Commentators prematurely assume a trade war

Weekly Investment View – 25 March 2018

The bell-weather S&P 500 index fell 5.95% last week in a marked ‘risk-off’ reaction to concerns about the possibility of a trade war after President Trump’s recent tariff announcements, as well as a further high-profile departure at the White House - with all this being fanned by data security issues at Facebook, which hit the social networking space. The first appearance of Jerome Powell at his inaugural after-FOMC policy briefing as the new US Federal Reserve Chairman - following the fully-discounted 25 basis point increase in the Fed funds rate - almost became just other items on the list of the week’s events, with the conclusion that markets generally took the Fed statement and ‘dots’ to be only slightly net-hawkish relative to the December meeting. Having initially threatened not to avert a possible US government shutdown, President Trump signed a $1.3 trillion spending bill passed by Congress, but did so rather grumpily (saying “never again”), seemingly on the basis that there wouldn’t be sufficient money to build his Mexican wall. Overall, the MSCI All Country World Index closed down 4.42%, while the Bloomberg Barclays Global-Aggregate bond index closed 0.61% to the good. In European equities, the STOXX Europe 600 index closed 3.15% lower over the week. Japan’s TOPIX index closed 4.13% lower, and China’s CSI 300 index was down 3.73%. Gold in dollars registered the ‘risk-off’ stance elsewhere (rising by just over $33/oz - or 2.51%), to $1,347.33/oz, as well as some weakness in the dollar, which closed 0.88% lower on its index (DXY: 89.436). The yen was notably strong, with the dollar 1.20% lower against it over the week, at ¥104.74. The euro rose by a restrained 0.51% vs. the dollar, to $1.2353, maybe held back by the March Eurozone IHS/Markit Composite PMI being below expectations, at 55.3, vs. 57.1 in February and a consensus estimate of 56.8 (so expansion is still quite good, although not as good as it was). In commodities, Brent crude was strong, up 6.40% over the week, at $70.45/barrel, mainly as the perceived Middle Eastern risk premium inflated further with the replacement of H.R. McMaster by the hard-liner, John Bolton, as US Security Advisor. Gold in euros, arguably a better representation of overall hedge demand for the yellow metal, rose by just under 2%, although without breaching medium-term downtrend lines.

“We are not concerned about a trade war”
Trump’s steel and aluminium tariffs of a few weeks ago now look like a negotiating ploy, given the exemptions granted so far.
The US will grant the EU and some other countries a temporary exemption from its steel and aluminium tariffs, based on criteria that are not yet public. As well as the EU, those exempt include Argentina, Australia, Brazil, and South Korea. In a new development last week, President Trump signed a memo effecting 25% tariffs on $60 billion of imports from China, supposedly to reflect a payback for China stealing US companies' intellectual property (IP) over the years, and said, “This is the first of many" trade actions. Following that, China made it clear it would retaliate, saying it intends to impose tariffs on about $3 billion-worth of US exports to China, with the expectation that these will be finely-targeted to hit Trump politically where it hurts the most. We understand that China will hit certain products in the technology sector - and of course China could always target US agricultural produce, a large proportion of which is exported to China (such as soya beans). A statement from China’s commerce ministry said, “China does not hope to be in a trade war, but is not afraid of engaging in one”, adding, “China hopes the US will pull back from the brink, make prudent decisions, and avoid dragging bilateral trade relations to a dangerous place”. After the imposition of tariffs on Chinese imports, US consumers could face higher prices, while US businesses will have to accommodate new arrangements and prices in its own product chains. To us, this smacks of political posturing to keep the average Trump voter on-side ahead of November’s upcoming mid-term elections (‘America First’), with the possibility of being able to say that such threats resulted in trade deficit control. Treasury Secretary Mnuchin will have already calibrated the ‘pinch points’ - how far can these actions be pushed without hurting US GDP growth prospects? Over the past five years almost a fifth of total US imports are from China. Irrespective of arguments about IP (and/or ‘dumping’), what about the possibility that the Chinese are in reality rather good at exporting – especially to the US? So far the Chinese response appears one of calmness, while there is no comparison between the $60 billion of targeted US import value and the $3 billion Chinese response on the one hand - and the $375 billion trade deficit that the US suffers with China on the other. Also in Mr Mnuchin’s mind is likely to be the fact that the Chinese are the largest holders of US government debt. This is not to say that China would dump those bonds, of course, however this needs to be seen as part of the big picture; China always takes the long view, and can afford to do so.

“Jerome Powell as FOMC Chairman equals continuity”
Turning to the Fed from last week:
In last week’s statement (and via the ‘dots’) the FOMC maintained their forecast for two further rate increases this year, although they now expect one more rate rise in 2019 than they indicated last December (making a total of three for that year). The US labour market remains strong, the economy continues to expand, and inflation appears to be moving toward the FOMC’s 2% goal, the latter helped by earlier declines dropping out of the year-on-year calculation. Growth in household spending and business investment appear to have moderated early this year, although the fundamentals underpinning demand remain solid and the economic outlook had strengthened in recent months. Fiscal policy has become more stimulative, ongoing job gains are boosting incomes and confidence, and foreign growth is firm. The median projection for the growth of real GDP this year is now 2.7% (up from 2.5%), 2.4% for 2019 (up from 2.1%), and 2% for 2020 (unchanged). The median projection for the unemployment rate stands at 3.8% for the fourth quarter of this year (down from 3.9%), is now 3.6% for the end of 2019 (markedly down from 3.9%), and is 3.6% for the end of 2020 (down from 4.0%) - and at 3.6% is almost a percentage point below its expected longer-run normal rate. Core PCE inflation is expected to be 1.9% at the end of this year (unchanged from the December forecast), and 2.1% at the end of 2019 and 2020 (both up from 2.0%). So compared with the projections made in December, real GDP growth is looking stronger, expected unemployment is lower, and inflation is slightly higher. The statement said that participants’ projections of the appropriate path for the fed funds rate ‘reflect our gradual approach’: the median projection for the fed funds rate is 2.1% at the end of this year, 2.9% at the end of 2019, and 3.4% at the end of 2020 (at which it would be modestly above its estimated longer-run level trend). Current market expectations for the Fed funds rate two years from now are 2.51% i.e. perhaps two hikes behind the ‘dot plot’.

“Inflation in the US should edge up, but should not take off”
Continuing with the Fed discussion, the statement said the program for reducing their balance sheet (which began in October), is proceeding smoothly, and barring a very significant and unexpected weakening in the outlook, they did not intend to alter it.
Turning to the Q&A, we thought the key points were as follows: Chair Powell said “…there's no sense in the data that we're on the cusp of an acceleration of inflation. We have seen moderate increases in wages and price inflation, and we seem to be seeing more of that”. Asked about any discussion of tariffs, confirming various members had mentioned this, the Chairman summarized their views: “…there's no thought, I think, that changes in trade policy should have any effect on the current outlook”. He confirmed, though, that “…trade policy has become a concern going forward for that group (business leaders)”. The Chairman reiterated the point that productivity has been very weak since the financial crisis, although, “…in the tax bill there are incentives…that allows expensing of investments (that should) encourage additional investment (and) productivity. In theory, an individual tax bill that lowers tax rates should encourage more labor force participation”. He added that, “...the current view of the Committee is that financial stability vulnerabilities are moderate…”, and that “…participants believe there will be meaningful increases in demand from the new fiscal policies for at least the next, let's say, three years…”. Touching on the Phillips Curve, he said, “...wages should in theory represent inflation plus productivity increases…productivity's been very low…(and) inflation's been low…so low wage increases make sense”. On yield curve inversion, he said: “…it's true that yield curves have tended to predict recessions, however (our italics), “…if you look back over many cycles, a lot of that was just situations in which inflation was allowed to get out of control, and the Fed had to tighten, and that put the economy into a recession. That's really not the situation we're in now…I don't think that recession probabilities are particularly high at the moment, any higher than they normally are”.

“Buy quality genuine IT stocks beaten-down by the social networking debacle”
INVESTMENT SUMMARY: (1) We don’t see a trade war, either globally, or between the US and China; Mnuchin says they are looking for a trade agreement;
(2) We view last week’s Fed messages as only slightly more hawkish; improving and moderate growth expectations are good, and (3) …especially when inflation expectations remain in a low range; last week’s rate hike was (a) fully expected, and (b) prudent; (4) The 10-year US Treasury yield closed three basis points lower over the week (at 2.8135%); that tactical bond bet is still on; (5) Large price falls in social networking stocks last week unfairly dragged down some excellent ‘genuine’ technology stocks; (6) Greater regulation of social networking companies runs the risk of P/E multiple contraction across the sub-sector; (7) For investors, last week’s Brexit transition deal time-frame ‘achievement’ misses the point - a transition to what, exactly? - and (8) The Asset Allocation Committee met last week and reiterated its bullish stance on global equities, despite short-term volatility.

For any inquiries related to this article, please contact Alain Marckus or Clint Dove.

Click here to download the article in PDF

Weekly Investment View – 25 March 2018

This report has been prepared and issued by Products & Services - Wealth & Private Banking (“P&S-WPB”) of First Abu Dhabi Bank PJSC (“FAB”) outlining particular services provided by P&S-WPB and does not constitute or form part of any offer or invitation to sell, or any solicitation of any offer to purchase or subscribe for, any shares in FAB or otherwise or a recommendation for a particular person to enter into any transaction or to adopt any strategy nor shall it or any part of it form the basis of or be relied on in connection with any contract therefore. This report is incomplete without reference to, and should be viewed solely in conjunction with the associated oral briefing provided by P&S-WPB. The report is proprietary to P&S-WPB and may not be disclosed to any third party or used for any other purpose without the prior written consent of P&S-WPB. The information in this report reflects prevailing conditions and our views as of this date, which are accordingly subject to change. In preparing this report, we have relied upon and assumed, without independent verification, the accuracy and completeness of all the information available from public sources or which was otherwise reviewed by us. In addition, our analysis are not and do not purport to be appraisals of the assets, stock or business of the recipient. Even when this presentation contains a kind of appraisal, it should be considered preliminary, suitable only for the purpose described herein and not be disclosed or otherwise used without the prior written consent of P&S-WPB. FAB clients may already hold positions in the assets subject to this report and may accordingly benefit from the buying or selling of such assets as referred to in this report. This document does not purport to set out any advice, recommendation or representation on the suitability of any investment, transaction or product (as referred to in this document or otherwise), for potential purchasers. Potential purchasers should determine for themselves the relevance of the information contained in this document and the decision to purchase any investment contained herein should be based on such investigation and analysis as they themselves deem necessary. Before entering into any transaction potential purchasers should ensure that they fully understand the potential risks and rewards of that transaction (including, without limitation, all financial, legal, regulatory, tax and accounting consequences of entering into the transaction and an understanding as to how the transaction will perform under changing conditions) and that they independently determine that the transaction is appropriate for them given their objectives, experience, financial and operational resources and other relevant circumstances. Potential purchasers should consider consulting with such advisers and experts as they deem necessary to assist them in making these determinations and should not rely on FAB for such purposes. FAB is acting solely in the capacity of a potential arm’slength contractual counterparty and not as a financial adviser or fiduciary in any transaction unless we have otherwise expressly agreed so to act in writing. FAB does not provide any accounting, tax, regulatory or legal advice. FAB is licensed by the Central Bank of the UAE.
London: Our London Branch is Authorized by the Prudential Regulation Authority. Subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from our London branch on request. Registered in England & Wales: Company No: FC009142: VAT No: GB245 3301 91.
Paris: Our Paris Branch is licensed by the French Prudential Control Authority as a credit institution. Our Paris is registered in France under the company number: RCS Paris B 314 939 547.
Switzerland: This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions as well as any prices indicated are currently as of the date of this report, and are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. At any time the First Abu Dhabi Bank PJSC and/or our Private Bank (Suisse) SA may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issuer. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. First Abu Dhabi Bank PJSC expressly prohibits the distribution and transfer of this document to third parties for any reason. First Abu Dhabi Bank PJSC and/or our Private Bank (Suisse) SA will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law. The “Directives on the Independence of Financial Research”, issued by the Board of Directors of the Swiss Bankers Association (SBA) do not apply.
Singapore: National Bank of Abu Dhabi P.J.S.C., Singapore Branch is regulated by the Monetary Authority of Singapore and holds a Wholesale Bank license.