Buoyed by more positive news on the US-China trade dispute, the S&P 500 gained 0.6% on Monday to close at a record high of 3,039, surpassing July’s previous peak.
President Donald Trump said he expects to sign a “very big portion” of the phase-one US-China deal ahead of schedule. Separately, the office of the US Trade Representative said it may renew a temporary suspension of tariffs on some USD 34bn worth of Chinese imports for 12 months. The suspension, set to expire on 28 December, relates to tariffs first imposed in July 2018.
But while we think an interim US-China agreement would remove an important risk overhang for markets, we remain cautious about the extent of further likely upside in equities:
* A trade deal might not be trusted. We think President Trump’s announcement of a Chinese commitment to buying USD 40–50bn of US agricultural products appears unrealistic – US exports to China peaked at just USD 26bn in 2012, when prices were much higher. A shortfall in agricultural purchase commitments might well lead to a re-escalation in the conflict further down the road. Longer-term trade issues on intellectual property and market access are likely to remain unresolved.
* Growth is slowing. We expect data this week to confirm that the US economy is weakening, with GDP growth likely falling below trend for the third quarter, manufacturing activity continuing to contract, and employment growth slowing. That said, we expect US growth to remain about twice that of the Eurozone.
* Corporate earnings are apparently contracting. While initial consensus forecasts may have been too pessimistic, at the halfway stage US 3Q earnings look to be in line with our forecasts for a 2% decline. For the Eurozone we expect profit per share to fall by 5% for the third quarter.
* We expect the Federal Reserve to cut rates this week, and it has scope to ease further in the coming year. But while we expect easier policy to support the economy, we don’t see it driving significant upside in equities. Lower rates are unlikely to spur a sharp rebound in investment, for example, since trade uncertainty has been the main reason for businesses to put off spending.
Overall we maintain a modest underweight to equities with a preference for US equities relative to Eurozone stocks, which reflects our view on the relative economic and earnings outlook. It is certainly possible that a positive surprise sends equities higher, such as an interim trade deal that includes an indefinite suspension of the December tariff increase, or a better-than-expected recovery in manufacturing. But, on balance, we continue to focus on earning yield rather than looking for higher equity prices. For example, in emerging markets we prefer USD-denominated sovereign bonds to stocks.