The recent escalation in the US-China trade war, including the export restrictions placed on Huawei and technology sharing by US companies, has led to a now-consensus view that as well as correcting trade imbalances, the US administration is seeking to constrain the rise of China. If accurate, this portends a more protracted and divisive trade war with a permanent constraint on technology transfers.
This has seen a significant “risk-off” trade and flight to safety, which has seen bond yields fall precipitously. Equally, gold has rallied and growth sensitive commodities, such as oil and copper, have seen large price corrections. Equity markets have not avoided this de-risking event, with global markets selling off sharply in May. Furthermore, within equity markets, this flight to safety has also continued with defensive and yield sensitive sectors continuing to outperform.
Essentially, markets are pricing that this impasse will have significant implications for global growth and corporate profitability. The inversion of the US yield curve is read as implying a 40% probability of recession. These moves reflect a growing belief that President’s Trump and Xi will need to see significant economic pain before any compromise is sought, let alone achieved.
Investors are now paying a record premium for safety, which reflects the inherent uncertainty of a potential paradigm shift in the global economic framework, with Trump unilaterally dismantling the rules-based, free-trade system that has been built since the Second World War.
We have previously noted that the recent premium paid for safety is largely unprecedented and further, has never been sustained at such levels. While this remains the case, the change in the environment leaves us cautious in regard to how and when this premium will normalize. As a result, we are reluctant to further add to our exposure to the more economically sensitive parts of the market.
Source: Brad Potter, Nikko Asset Management