Stocks see surprisingly swift boost from US-China trade outlook

Do they un-ring a bell at the bottom of the market? The tariff war between the US and China provoked a temporary shutdown of capital investment due to uncertainty about the global supply chain. That is a bell that is hard to un-ring, but the expectation of a deal has brought a surprisingly swift measure of relief to equity markets.

Strong performance by Chinese stocks last week affirms my view that expectations of a US-China trade deal will prompt a recovery in China-sensitive equities.

On Jan. 21, I predicted a rotation in the equity market towards capital goods. We began to see that rotation last week. Most notably, there also has been a rally in shares of capital-goods companies, most vividly in Japan. The Machinery component of the Topix index rose by 15.4% in the four weeks ending Jan. 25, and the best performers within the sector are mostly semiconductor equipment manufacturers.

TOPIX Equipment Manufacturers Lead Japan’s Rally:

Globally, industrials with a high proportion of China business outperformed the broad market, including the German automakers and capital-goods firm like Siemens.

The recovery in the broader China complex of global equities is noteworthy considering that backward-looking indicators of world trade and industrial activity continue to point downward.

Emerging Asia imports, for example, were running at an annual growth rate of close to 10% through most of 2018, and then slid to zero growth in November, according to world trade volume data released Jan. 25 by the Netherlands Central Planning Bureau. Germany’s IFO Institute meanwhile reported the lowest manufacturing expectations number since 2012 in its December survey.

None of the available data suggest that there is any macroeconomic improvement. That leaves expectations of policy change as the only remaining explanation.

President Trump badly needs a victory of some sort after his failure to force Democrats to agree to his border wall, following a prolonged shutdown of the federal government. He has been at pains to dispatch senior officials to report progress in trade negotiations with China every time rumors of failed negotiations upset the stock market.

China meanwhile is anxious to resolve the matter, if necessary by spending annually an additional $600 billion on American goods. That is a concession that Trump can hold up to the electorate. The supposedly difficult negotiations, e.g., IP protection and forced technology transfers, are hazy and subject to interpretation.

I continue to expect that China will give Trump assurances sufficient to enable him to declare victory.