2019 Midyear Market Outlook

U.S. - China: Fallout from Trade Tensions?

Stimulus programs from central banks should head
off inflation, even as negotiations continue.
Despite a brief pause to the trade conflict agreed to by Presidents Xi and Trump during the G20 Forum at the end of June, we expect tensions between the U.S. and China to be a continuing source of uncertainty for markets. With the remarkable rise of China in recent decades, we now very much live in a bipolar international system. This is inherently more unstable than the unipolar world in which the U.S. was the only global superpower.

In the U.S., a more aggressive stance against China has become one of the few issues with bi-partisan support. Both political parties are keen to appeal to voters in the “rust belt” states who have been impacted by the shifting of jobs to cheaper labour forces offshore. In China,  Xi has asserted the importance of the Communist Party and its economic model and has little reason to accept external demands for structural changes.

Over the next 6-12 months, U.S.-China tensions will likely continue to create uncertainty. In our view, however, there is little chance that the global economy will be pushed into a recession. This is due to what we believe is the potential for Chinese stimulus throughout the second part of the year, along with an expectation that major central banks will take a dovish turn.

It is important to note that the Chinese economy was slowing prior to the trade conflict. In general, there has been a shift toward rebalancing China’s economy from one dependent on the debt-fueled building of apartments, factories and bridges to one with a greater focus on domestic consumption and services. This being the case, China has until recently held back on reverting to economic stimulus, with few apparent moves to direct banks to lend to SOEs (State-Owned Enterprises) for development purposes.

The slowing of the world’s second-biggest economy has seen the rest of the world’s economy begin to slow as well - with one exception, the U.S. (or so it seemed). Recently, however, this has been called into question, with U.S. leading economic indicators, such as PMIs (shown below), starting to soften:
ISM Manufacturing PMI
Source: Factset, as of 6/30/19. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Despite record low levels of U.S. unemployment, inflation has been missing in action. A slowing global economy, overlaid with the trade war, has led the Federal Reserve to switch from a tightening monetary policy last year to a loosening bias this year. The European Central Bank subsequently followed suit. The trade war has also forced Beijing to broaden its economic stimulus beyond that targeted at the consumer (such as tax cuts) to more traditional measures, such as spending on infrastructure.

These two factors, namely a looser monetary policy and Chinese stimulus starting to find traction, will in our view ensure that a recession is avoided. After all, the U.S. consumer continues to be in fine form. With unemployment at multi-decade lows and wage growth starting to come through, consumer sentiment is still very strong. In this environment, we believe that investors should remain fully invested in equities.

This being said, given the uncertain global backdrop and the later stage of the economic cycle, we believe investors should consider at least some of their portfolio allocated to more defensive equities, such as infrastructure and utility stocks. While this sector of the market has rallied significantly so far, we still see opportunities. For instance, we believe one area in which quality infrastructure companies are being undervalued is in UK utilities. Brexit, along with the UK Labour Party talks of nationalisation, has led to periodic, indiscriminate sell-offs. 
2019 Midyear Outlooks
Brandywine Global
Growth: Turning a Corner
Clarion Partners
The Momentum Continues
ClearBridge
Cautious Optimism for Equities
EnTrust Global
Realistic About Risk
Martin Currie
Looking Beyond the U.S.
QS Investors
Where Do We Go from Here?
RARE Infrastructure
U.S.-China: Fallout from Trade Tensions?
Royce & Associates
Cyclical Thinking
Western Asset
Resilient Growth, Despite Uncertainty

Investment risks:

Companies in the infrastructure industry may be subject to a variety of factors that could adversely affect their business or operations, including high interest costs in connection with capital construction programs, high degrees of leverage, costs associated with governmental, environmental and other regulations, the effects of economic slowdowns, increased competition from other providers of services, uncertainties concerning costs, the level of government spending on infrastructure projects, and other factors.


Definitions:

Leading Economic Indicators (LEI) are measurable economic factors that change before the economy starts to follow a particular pattern or trend. While they are used to predict changes in the economy, they are not always accurate.

The Institute for Supply Management (ISM) is an association of purchasing and supply management professionals, which conducts regular surveys of its membership to determine industry trends.

The Group of Twenty (also known as the G-20 or G20) is an international forum for the governments and central bank governors from 20 major economies. The members include 19 individual countries—Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico,

The Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

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