October 13, 2019

Phase One Commences

Beginning with the Bottom Line:

 

U.S. and China trade headlines moved the needle again this week. Two days of high-level trade negotiations concluded on Friday with a partial trade deal announced, although not completed. The week started rocky with companies being added to the Chinese export blacklist, but progress was made towards “phase one” of a trade agreement between the world’s two largest economies. The U.S. agreed to delay the increase of tariffs, and in turn, China will purchase $40 to $50 billion worth of agricultural products and make concessions on their currency and a couple of other issues. The tentative timeline for completion is at an international conference in five weeks. Global stocks reacted positively, the yield curve steepened, and the dollar weakened in response to the first steps toward an agreement since May. It’s positive news, although much more work remains. We need a little less talk and a lot more action. Hat tip to Toby Keith.

 

The Full Story:

 

Global equity markets rallied Wednesday through Friday on encouraging trade headlines to finish the week on a positive note. China’s lead negotiator Vice Premier Liu He was in Washington for two days of high-level trade talks, culminating in a meeting on Friday with President Trump.

The week got off to a shaky start when the U.S. announced that it had added 28 Chinese businesses to the export blacklist. There were at least eight technology businesses that joined Huawei Technologies Co. (added in May) to the blacklist, meaning their suppliers cannot provide them any technology that originates in the U.S. The U.S. Department of Commerce implicated the companies in human rights violations and abuses toward Muslim minority groups in northwest China’s Xinjiang region. The timing was either purely coincidental (wink), a leverage point, or just a barbed jab.

That potential landmine appeared to be sidestepped as positive reports and headlines started to come out and build some positive momentum.

 

From Wednesday, October 9th:

»  “Low expectations for trade talks: ‘If you’re looking for good news, they didn’t cancel the trip’” – CNBC

»  “China Open to Small Trade Deal If Trump Eases Tariff Threats” – Bloomberg

»  “Trump says there is a ‘really good chance’ of U.S.-China trade deal” – Reuters

From Thursday, October 10th:

»  “Day 1 of U.S.-China trade talks ends with hopes for limited deal” – Reuters

»  “Trump Says Day One of U.S.-China Trade Talks Went Very Well” – Bloomberg

»  “U.S.-China Trade Talks Begin on Positive Note” – Wall Street Journal

On Friday after two days of trade talks, President Trump announced that negotiators had reached a “Phase One” agreement. Now, it’s not a done deal. Trade officials will be working on the agreement for the next few weeks to, hopefully, be completed by President Trump and Chinese President Xi Jinping at the Asia Pacific Economic Conference, scheduled for November 16th – 17th in Santiago, Chile. As today’s title implies, we are wary of positive trade headlines over the past two years, but that’s not a reason to ignore it.

 

 

Key Issues

» China agrees to purchase $40 billion to $50 billion worth of American agricultural products, eventually scaling up to that amount annually. In 2017, China stood as the number two importer of U.S. agricultural goods at $19.6 billion (slightly behind Canada’s $20.5 billion), including more than half of the U.S.’s soybean production. In 2018, that amount was more than cut in half to $9.2 billion.

 

 

» China agrees to certain intellectual-property measures, concessions related to financial services, and currency management. We received relatively few details on these measures, which leaves room for negotiators.

» U.S. agrees to suspend a tariff increase on $250 billion of Chinese goods. Tariffs were scheduled to increase from 25% to 30% on October 15th. The truce staves off the upcoming tariff increase, but there was no mention of delaying or removing the 15% tariff on consumer goods scheduled for December 15th.

 

 

Clearly, there is still uncertainty. First, instead of a comprehensive deal, we appear to be headed for multiple trade agreement phases. President Trump mentioned at least two phases if not three in the Friday press conference. Second, the phase one deal hasn’t even been completed or written yet, and contentious issues remain. Chinese state news agency Xinhua reported that negotiators made substantial progress toward a final agreement, but stopped short of calling Friday’s outcome a deal. There was also no mention of a potential deal signing next month.

Any progress should be viewed as constructive, and risk assets did react positively on Friday. However, stocks did pare their gains as details of the phase one agreement were announced. The S&P 500 moved from +1.82% to +1.09% in the last 25 minutes of trading.

 

U.S. Dollar Strength

Last week, David covered the potential weakness in corporate earnings if trade issues persist, which could further damage manufacturing and then services sectors. There is another pressing issue on corporate earnings, particularly in manufacturing, that is coming to the forefront – a strong U.S. dollar. Multinational U.S. companies struggle with a strong dollar due to the comparative pricing of foreign goods, and foreign-made sales deteriorate when converted back to a stronger currency.

It’s a small sample size currently, but half of S&P 500 companies that have reported 3rd quarter results have cited currency exchange as a factor that had a negative impact on earnings or revenues.

By its broadest measure, the U.S. dollar is stronger than peaks reached earlier in this economic cycle, which on the first occasion in late 2015 also correlated with weak Institute of Supply Management (ISM) manufacturing readings. This time around, the added trade uncertainty has meant even further downside in export orders.

 

Have a great Sunday!

 

Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist

 

Sources: CNBC, Bloomberg, Wall Street Journal, Bespoke Investment Group, New York Times, FX Street, FactSet, Reuters, Financial Times, South China Morning Post

Author

Author Image

Timothy W. Ellis, Jr., CPA/PFS, CFP®

Senior Wealth Strategist

Timothy W. Ellis

Sign up to receive the weekly W&A Weekly Strategic Insights in your email.