It took fewer than 240 characters on a Sunday afternoon in early May to re-ignite the trade conflict between the world’s two biggest economies. While trade war was a relatively remote risk a few weeks ago, hawkish voices in the Trump administration look eager to impose punitive tariffs on the European auto sector by November. The good news is that central banks led by the PBoC and the Fed will keep an accommodative bias, mitigating the trade stress experienced by financial markets.
This spring, we have already reduced our tactical exposure to equities as markets recover strongly from the collapse in Q4. Candriam was therefore positioned for a consolidation in equity markets – the jury is still out as to whether the current episode will turn out to be a consolidation or a more severe correction. Clearly, we expect volatility to remain headline-driven until the G20 summit in Osaka on 28-29 June, but take note of two powerful forces which explain our longer-term slightly constructive view: the turn of the current mini-cycle and policy support.
Since the start of the year, the fiscal, monetary and credit stimulus initiated by the Chinese authorities in 2018 has been increasingly in force. The Chinese economy appears to have bottomed in early 2019 and any new weakness is likely to be met by further accommodating measures. As shown by the OECD leading indicators, the current cycle has been led by China since the deleveraging in 2017, followed by the Euro area. For the latter, the most recent escalation in the trade dispute again increases the uncertainty surrounding manufacturing exports, in particular in Germany, but the recession risks seem removed as domestic demand remains solid, witness the Q1 GDP data. The US, which traditionally leads the world economic business cycle, has pushed its domestic cycle somewhat, thanks to the fiscal stimulus which took effect in 2018. It should therefore come as no surprise that the landing, and the upturn, is coming at a later stage there.
Chart 1 - OECD Leading indicators reveal that the current mini-cycle is led by China, followed by the Euro Area, then the US.
As a result, downward revisions to growth expectations for 2019 should come to an end; this is also supported by the latest G20 production and consumption data. In much the same way, EPS expectations kept falling until the Q1 earnings season. The current stabilization looks somewhat fragile but, at mid-single-digit levels for 2019, profit-growth expectations now seem to be more reasonable than at the start of the year, given expected GDP growth.
Currently, equity markets have started to price in headwinds from the trade conflict. Actually, at 13.0x earnings, 12-month forward valuations for non-US markets now stand barely above the lows registered in 2016. In the Euro area, cyclicals are factoring in a renewed drop in manufacturing PMIs. Emerging markets have not recovered from last year’s disappointing perfomance, neither in absolute nor in relative terms. Within an overall slightly constructive equity medium-term allocation, these two regions retain our preference, in spite of trade-related headwinds.
Chart 2 - Non-US market’s 12m forward PE barely above lows registered in 2016