This week saw the consummation of the U.S.–China Phase One Trade Deal. The pause in trade tensions is welcomed after the U.S. and China have been engaged in a two-year cycle of levying and raising tariffs. This cycle of trade tensions hurt business confidence in both the U.S. and China, resulting in companies delaying or canceling investment projects, and introduced trade-linked volatility into markets. Capital markets have been reacting positively since the news was announced in October, which happened to coincide with another important announcement from the Federal Reserve. The fiscal and monetary policies relief has led to extremely low levels of stock market volatility and a steady grind upwards.
On Wednesday, the U.S. and China, at last, signed a “Phase One” trade agreement. The deal was first announced on October 11th, but as we covered in that week’s Insight, the announcement was lacking details as well as a full endorsement from Chinese officials. The crux of the announced deal was that China agreed to buy $40 – $50 billion of agricultural products, and the U.S. would halt tariff increases in return. It has taken trade representatives a full three months to work through complete terms as well as basic logistics to get a trade agreement signed.
So, what made it in the actual deal?
The agreement includes the U.S. suspending its next planned round of tariffs, un-designating China as a currency manipulator, and cutting the existing tariff rate from 15% to 7.5% on approximately $120 billion of goods (25% tariffs remain on another $250 billion of goods).
In exchange, China will boost its imports from the U.S. by approximately $200 billion over the next two years, allow greater access to its markets for financial services firms, enforce intellectual property protections, and be more transparent in its currency management practices. The full list of Chinese concessions, organized by topic area, is included in the chart below.
You probably can’t point to any of these items as huge surprises; however, the overall expanded level of Chinese imports at $200 billion above their 2017 imports level is big enough to be meaningful if they hold up to their end. For reference, China bought $186 billion of U.S. goods and services in 2017; therefore, there will need to be a substantial surge in purchasing to meet these Phase One targets. China does have an “out” for market conditions and commercial considerations.
Phase One implies that there are multiple phases of a comprehensive trade deal to be done, but there is no timetable or outline for that process. China is only agreeing to the expanded purchases for the next two years. Afterwards, the agreement states that the countries “project that the trajectory” of increased purchases would continue through 2025.
The major item that U.S. officials will want to address in future negotiations is the Chinese industrial complex including the use of subsidies and state-owned enterprises to gain competitive advantages. U.S. officials also likely want a prolonged period to monitor China’s compliance with phase one, specifically the goods purchases, before moving on to phase two.
The market impact of the signed agreement was positive for stocks and risk assets, although a bit muted because we had been slowly moving towards it for more than three months. Equity markets have been remarkably calm while grinding higher during that same period. The S&P 500’s last daily decline of more than 1% was on October 9th, which is a streak of 67 trading days. Maybe even more interesting is that the S&P 500 also hasn’t had a 1% daily advance. It’s been 67 trading days or more than 3 months since the U.S. large-company stock index had a 1% move in either direction. During that time, the index is up 14%.
We don’t think it’s a coincidence that stocks started this relatively smooth ride up at almost exactly the point where trade tensions began easing. Funnily enough, another important event happened on October 11th that is also not coincidental to the move in stocks. The Federal Reserve announced its plan to purchase $60 billion of bonds each month and continue those purchases into the second quarter of 2020. The announcement marked an about-face for the U.S. central bank, which until August had been shrinking its nearly $4 trillion balance sheet.
So, on Friday, October 11th, the Trump Administration announces that they have reached a “Phase One” trade deal with China, and the Federal Reserve (possibly in a Friday news dump to avoid the implication of another round of Quantitative Easing) announces that they are pumping liquidity into the market to the tune of $720 billion annualized.
The combination of those two events along with general economic slowdown fears easing among investors has resulted in a melt-up in stock prices. Dr. Ed Yardeni refers to this current environment of rising investor optimism and rising stock prices as not without dangers or opportunities. “If the melt-up continues, then the stock market’s valuation multiple will rise toward nose-bleed levels. If that sets the stage for another meltdown correction like the one during Q4-2018, it would probably be yet another buying opportunity and not the end of the bull market. It’s credit crunches, which lead to recessions, that cause bear markets.
So for now, we have nothing to fear but nothing to fear.”
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist