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After a pretty tumultuous and volatile end to 2018, global equity markets have performed in a pretty stellar fashion to date in 2019. Up to Monday evening, May 13th, the Dow Jones Industrial Average is up 8.9%; the S&P 500 is up 12.3%; the FTSE 100 is up 6.5% despite immense Brexit-induced economic and political uncertainty; the German DAX is up 12.5%; and the French CAC is up 11.2%.
Despite clear signs of stress in global economic activity, and more particularly a downgrading of global growth prospects for 2019 from official forecasting agencies such as the IMF and the OECD, markets have maintained remarkable momentum.
They have been propelled higher by a number of factors.
There has been a significant revision to global interest rate forecasts. It is clear now that against a background of visible weakness in the Euro Zone economy and very well-behaved inflation, the European Central Bank (ECB) will not increase interest rates during 2019 and it is certainly possible that rates might do very little if anything in 2020.
In the US, the Federal Reserve has changed its three-year stance of interest rate tightening and any further tightening in the US interest rate cycle looks highly unlikely, or at least that is how the markets currently view the situation and it is hard to disagree.
The markets were also worried last year that Quantitative Easing (QE) would start to be reversed this year and liquidity conditions would tighten as a consequence. Such Quantitative Tightening is now not an issue or indeed a threat. Central banks will be very aware that the global economic growth outlook is sufficiently fragile to necessitate keeping liquidity conditions as loose as possible around the global financial system.
Bond yields have also fallen back, with the US 10-year now down at 2.4%. Last year when this rate went through 3% it sparked significant nervousness on global equity markets, but the breach did not persist for very long. Meanwhile the equivalent German yield is -0.07%. We still live in a world of unusual financial market conditions.
All of these factors and more have ensured that equity markets have had a very easy ride so far this year, that is at least until recent days. A bout of intense nervousness has started to creep in as President Trump has started to significantly increase pressure on China to agree a trade deal.
On Friday last, President Trump announced that he was going to increase tariffs on $200 billion in Chinese imports to 25%. On Monday, the Chinese retaliated by announcing that it was raising tariffs on a range of imports from the US. Trump is due to announce further measures shortly.
All in all, this tit for tat trade dispute is not yet that material, but it is starting to escalate at a worrying pace and is starting to threaten growth prospects for the world’s two largest economies quite significantly.
From a European perspective, apart from the threat to global growth from the threat to free trade, the danger that flows from all of this is that President Trump starts to deliver on his threat to increase tariffs on all auto imports. The US recently suggested that vehicle imports are a threat to national security and hence the impending threat to increase levies. The German auto industry would be most exposed to such moves in the EU, which would not be good news for an economy that has already seen a marked weakening in economic activity over the past year.
What we are now seeing in a meaningful way is an escalation of the isolationist economic and political agenda that President Trump has been increasingly adopting since his election in November 2016. If the world enters into a more protracted and more serious trade war, global growth will be hit, and an economy like Ireland, for whom foreign direct investment (FDI) is so important, and for whom exports make up such a disproportionate level of GDP, would be very exposed and vulnerable.
Even if the current escalation of trade tensions between the US and China were to be resolved in an amicable fashion, the danger is that it would just be a temporary reprieve. The reality is that the US and China have fundamentally different economic and political belief systems and there is a very large bilateral trade deficit between the two countries.
The US wants China to buy more of its goods, ease rules that prevent US companies exercising the sort of control they would like to on their investments in China, address the theft of intellectual property rights by Chinese companies, and cease distorting competition by heavily subsidising its companies. The political rivalry and differences between these two immense superpowers will not be solved easily, particularly with the isolationist attitude of Trump and growing pressures for self-reliance in China.
One hopes that good sense and sanity will prevail, but based on what Brexit has shown us over the past three years, sanity is not always in abundance in political circles. Meanwhile, equity market investors have reason to be somewhat nervous because at a fundamental level, free trade is an important driver of corporate earning in most global companies of significance.
IMPORTANT: This publication is based on data up to 13/05/2019. It is subject to change without notice.
The views and opinions expressed in this article are those of the Author and not Aviva.