Among the (known) variables driving investor forecasts for 2020, the US-China trade war is number-one. Nothing else comes close. Will it be resolved? Will it escalate? Will it simply drag on like a bad soap opera?
If a buoyant stock market is a prerequisite for Trump’s reelection, then a trade-war resolution in 2020 is all but assured. On the other hand, if continued China bashing proves to be a reliable tool for energizing his base, then we can expect the trade war to remain a centerpiece of the Trump presidency. Either way, any forecast for 2020 must consider how (or if) this ends.
To quantify the influence of this geopolitical football on Asian equity markets, we designed two stress test scenarios labeled “Trade War Escalates” and “Trade War Resolution” in the tables below. As the names suggest, the former is designed to show the impact (in terms of expected loss in %) if tensions intensify between the US and China on this issue, while the latter illustrates the likely effects of the signing of a mini-deal and/or a clearly communicated path towards conflict resolution.
Given that this issue has been top-of-mind for investors since March 2018 (The timing of the first round of tariffs, though the issue has been on the table since Trump’s presidential bid in 2016) and has seen several reversals in the recent past, we now have ample relevant history to reuse for our forecasting purposes.
The period from May 3 to June 3, 2019 is representative of a collapse in the negotiations and an escalation in the conflict rhetoric. During that period, Trump tweeted his intention to raise tariff rates on $200 billion of Chinese goods to 25% on May 10. After formally informing his Chinese counterpart, articles in the media reported that China had backtracked on almost all aspects of an earlier draft US -China trade pact, which had been the source of enthusiasm for investors up to that point.
Conversely, the period before the collapse in negotiations was a time of growing optimism for investors, on hopes that a full-blown trade war would be avoided. On Monday, December 3, the United States and China agreed on a 90-day halt to new tariffs. Trump agreed to put off the January 1 scheduled increase on tariffs on $200 billion of Chinese goods until early March, while talks between the two countries continued.
In exchange, China agreed to buy a “very substantial” amount of US products. On Monday, February 25, Trump extended the March 1 deadline, leaving the tariffs on $200 billion of Chinese goods at 10% on an open-ended basis. We can therefore use the period of February 25 through to April 29 as a guide for how markets would react under a resolution scenario.
The table below shows the predicted impact on a portfolio of Asian equities using the holdings as of November 29 under both scenarios, broken down by country, and reported as individual country gains/losses. Those results highlight the binary nature of this conflict for Asian investors.
The cost of an escalation would be on the order of a 6.5% loss for a pan-Asian portfolio, while a path towards resolution would yield a 3.1% gain. China, as a direct participant in this scenario, would vary the most, losing up to 12.1% if tensions escalate and gaining 4.7% if they de-escalate. The outcome for Taiwan would also vary greatly from a 7% loss to a 6% gain. Hong Kong and South Korea would also face large losses of almost 10% and 9%, respectively, but would not benefit from a de-escalation scenario due to their own domestic circumstances.
Interestingly, India would benefit in either scenario, or at least that is how investors felt during both periods used in these stress tests.
Source: Axioma Risk
We should note that the rise in investor sentiment in the February-April 2019 period was based on hopes for a comprehensive trade deal signing and a reversal of all tariffs. We are clearly not anticipating either of those outcomes today. All that is expected now is a mini deal that might prevent additional tariffs from kicking in on December 15.
Also note that since the idea of a mini deal was floated in early October, our pan-Asia market portfolio has already risen by almost 5%. So, given the reduced scope of the current resolution scenario, and the fact that a mini deal seems to have already been bought and paid for by investors, nothing short of the start of a bromance between the two leaders will do for history to repeat itself again in 2020 and deliver further upside.
We might instead see a ‘sell-on-the-news’ reaction if investors see it as too little too late for the economy and the earnings cycle.
Author: Olivier d'Assier, head of applied research, APAC at Qontigo (Axioma is now a part of Qontigo)