Q3

Trade fears grip markets – August 2019

An escalation of trade hostilities between US and China is likely to bring continued volatility, but we are well positioned

07 Aug 2019

Investment Team

August is not turning out to be the quiet month in markets many investors will have been hoping for. Global equities are down over 4% in the first few trading days of the month, with many stock markets experiencing falls of 2-3% on Monday 5 August. Investors have been seeking safety in long-term government bonds, sending yields to multi-year lows. 

There are two reasons for the risk aversion. The first is the disappointing commentary that accompanied the Federal Reserve’s first interest rate cut in eleven years. Investors had been hoping this would be the first in a series of cuts. However, Fed Chairman Jerome Powell stressed that this did not mark the start of a rate cutting cycle.

The more worrying reason is an escalation in the US-China trade dispute. President Trump announced on the first day of August that he would impose a 10% tariff on $300 billion of Chinese imports. Just over a week later, China responded by allowing its currency to fall below the key 7.0 level versus the US dollar for the first time in a decade. It also asked state-owned enterprises to suspend purchases of agricultural imports from the US. Both parts of China’s response are significant.

US farmers, who already rely on government subsidies, will worry about the halt in crop purchases becoming permanent, as China makes more use of alternative sources for agricultural products, such as Brazil.

The US has long accused China of using its currency as a means of gaining an unfair competitive advantage for its exports in global markets. For the past few years, China has reduced tension by keeping its currency within a narrow range. By now letting it move outside this range, Beijing is indicating that it is willing to use all the tools at its disposal if the trade dispute turns into a trade war. We expect to see further managed depreciation of the yuan. However, the fact that that the exchange rate has stabilized suggests that China is not – for now – looking for an aggressive devaluation.

China-US trade relations: outlook

Though we do not expect the situation to be resolved quickly, there are reasons for both sides to seek to de-escalate the dispute. There is a US election next year and Trump will be mindful of doing real damage to the US economy. Tariffs would also hit the Chinese economy, which many suspect is weaker than official figures suggest. This in turn would raise the risk of political unrest, something the government will be especially keen to avoid given the difficult situation in Hong Kong.

Portfolio positioning

We have been concerned about the potential for higher levels of volatility in markets for some time and have been positioning for it.

We took advantage of strong equity markets in the first half of the year to trim our higher risk equity positions. This has left us with a higher-than-usual allocation to cash across most portfolios, providing some insulation from recent volatility. We also have significant exposure to alternative investments, with a large position in gold. Over the past year, we have been disciplined in focusing our alternatives exposure on those investments that can perform well when equity markets struggle. This strategy is starting to pay off, with gold in particular benefiting from recent volatility.

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Investment Team

 

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