On the Minds of Investors
Should investors cheer Brexit progress and trade agreement?
The latest progress on U.S.-China trade negotiation and Brexit are a small step in the right direction. However, investors should not be too carried away since there are still both short-term and long-term hurdles to these geopolitical challenges. Volatility management is still the top priority when it comes to portfolio construction.
On U.S.-China trade, the tentative agreement has avoided the tariff increase scheduled for October 15, but another increase by mid December is still under negotiation. Presumably this will be on the agenda between two sides in coming weeks running up to the Asia-Pacific Economic Cooperation (APEC) Summit in Santiago in mid November. While we are still waiting on the details on concessions made by either side, it seems these are the low hanging fruits that Beijing has offered in the past, such as buying more U.S. agricultural products, and allowing greater market access to international companies.
Meanwhile, many of the more challenging issues, such as intellectual property rights protection, forced technology transfer, and the U.S. blacklisting Chinese technology firms, should be more difficult to resolve. The bipartisan view that China is a long-term competitive threat in technology and geopolitics would mean a sustainable deal would be hard to achieve, even beyond the 2020 elections in the U.S.
On Brexit, British Prime Minister Boris Johnson’s latest proposal is being considered by the European Union (EU). Investors are cheering merely on the fact that negotiation has not hit a dead end. There are two key events this week that will determine Brexit’s course. The EU Summit on October 17-18 will decide whether the Europe accepts Johnson’s revised proposal. Assuming this goes through, the new deal would need to go through the UK parliament. This remains a close call as the Democratic Unionist Party has voiced opposition, since it insists on Northern Ireland to remain as part of the UK customs union. (For more detail, please see AM Market Response: Brexit in the Week Ahead – Crunch time)
Weak corporate spending and investment is currently the biggest threat to global economic growth. International Monetary Fund’s latest economic projections for 2019 and 2020 should confirm this concern. Neither of these latest developments in U.S.-China trade or Brexit would convince global business leaders that uncertainties are over. In fact, we have seen a similar truce between the U.S. and China in last year’s APEC Summit that collapsed six months later. We would also urge investors to be careful not to get ahead of themselves.
EXHIBIT 1: U.S. REAL YIELDS STILL HIGH RELATIVE TO OTHER DEVELOPED MARKETS
REAL AND NOMINAL YIELDS*
Near-term investor sentiment is likely to be dictated by news headlines, especially around the progress on U.S.-China trade negotiation and Brexit. We believe it is important to focus on economic and corporate fundamentals, as well as the investment principle of diversification. The risk of an economic recession in the U.S. over the next 12 months remains low at this stage. However, growth rates should remain subdued and this will put pressure on corporate profit growth. This is a challenge since analysts’ earnings expectations for 2020 remain too high, in our view.
Fixed income continues to play an important role in portfolio construction and the prospects of more monetary easing by central banks around the world should continue to benefit this asset class, especially for long duration high quality bonds. U.S. Treasuries are attractive since the Federal Reserve is expected to cut rates further in months ahead. Also, its yields are high relative to other developed markets. Investors can also choose from selected emerging market fixed income, since they also enjoy monetary loosening and high real yields.