The economic clock continues to tick. The relief sparked by fiscal easing and a de-escalation of US-China trade tensions has faded. Now, the trade war is heating up again and the yield curve – a traditional recessionary gauge – has inverted, suggesting a downturn might happen within the next two years.
We are 10 years into a global economic expansion, which is close to a record. The equity bull market is of similar vintage. Draining dollar liquidity is pressuring some sectors and political risk is mounting. The recent European parliamentary elections highlighted the strains within the EU; the UK is in the midst of a conservative leadership battle; and the run up to the 2020 US elections is gathering pace.
Now is not the time to focus only on upside opportunities. The hour is late in the economic cycle and the risks in these uncertain times are considerable.
Investors need to think hard about adding defence to their portfolios.
When change is constant, what are the risks?
From the dismal last quarter of 2018 to now has been a rollercoaster. We have gone from markets pricing in a global recession by this time in 2019; to a record-breaking first quarter rally across asset classes helped by policy easing and the prospect of a US-China trade deal; to fears that the world’s two largest economies are readying for something much worse than a simple trade war.
The last few weeks have seen negotiations sour faster than you can say “tariffs”.
Neither side looks likely to yield until they get what they want or something gives. For the US, stock markets seem to be the pain point; for China, it’s the broader economy and access to global markets.
With tough talk on tariffs threatening economic growth and dragging down the Dow Jones Industrial Average, Washington’s approach seems in conflict with ‘market-man’ President Trump’s ideals. But this is no longer just a trade war. It is a battle for dominance with more at stake than the economy and stock prices. Increasingly, the US is framing its dispute with China in terms of national security, with intellectual property rights, technology and China’s involvement in early stage venture capital and M&A projects under scrutiny. Political concern over this issue is gathering momentum if the number of tweets is a gauge, highlighting that the narrative can turn on a dime. Trump has shown that he’s not just a market man, but a ‘tariff man’ as well:
“...I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so. It will always be the best way to max out our economic power. We are right now taking in $billions in Tariffs. MAKE AMERICA RICH AGAIN [sic].”
President Donald Trump, Twitter, 4 December 2018
The focus of the tariffs mirrors the US electoral map. They are directed particularly at areas of relevance to the US farm states, where many votes could be won. With the US economy doing well so far this year, it is no surprise that Trump is pursuing a protectionist policy heading into 2020.
Our concern is that this scrap could be more dangerous than many people have assumed. It may mark the beginning of a drawn out de-globalisation of the global economy and its intricate value chains. Investors should be careful not to let seemingly positive data mask the risks arising from the lateness of the cycle, whose negative impact may take time to appear in asset prices. Even if the trade dispute is resolved, it would only be a short-term fix. De-globalisation is a long-term theme.
In any case, the current situation might get nastier before it gets better. We may need a reaction from markets and an impact to growth before either side capitulates. We deem this reason enough to be adding robust defence to portfolios.