Geopolitics, largely related to US trade, will play a significant role in how China’s picture evolves from here.
More broadly, protectionist rhetoric has risen appreciably since US President Donald Trump was elected, with a swathe of new tariffs and uncertainties. While such measures were threatened in Mr Trump’s presidential campaign, words turned into actions as the November 2018 mid-term elections approached.
Investor uncertainty over trade policy is now extremely high, and a further planned escalation in Chinese tariffs in 2019 – though currently postponed – gives further cause for concern.
Protectionism like this is generally bad news for risk assets like equities, which are perceived as losing long-term value in such scenarios. Meanwhile, tariffs on Chinese goods have also effectively resulted in higher prices for US consumers, creating a drag on growth and inflationary pressure.
Recent trade talks appear to have been more positive, and we feel that White House pragmatism will ultimately win out and some resolution will be found – not least because a Chinese economic crisis serves no one – but putting a timeline on a positive sustainable outcome is fraught with difficulty.
Meanwhile, Fed chair Jerome Powell’s reaction to financial market turbulence in October 2018 and weakness in certain sectors of the US economy (housing and manufacturing) was conspicuous in its absence.
While the Fed has dialled down its expected number of rate hikes for 2019, Mr Powell’s reluctance to engage with investment markets may yet continue.
A serious enough event could change the Fed’s attitude, but for now the central bank continues with its rate-rise agenda. The Fed’s stance is already showing up in various corners of the world, with emerging markets, which have borrowed meaningfully in US dollars, enduring a rise in their borrowing costs.
Fed policy remains a key risk going into 2019, but could rapidly recede if the Fed dials down its agenda.
No investment outlook would be complete without reference to the ‘B-word’, Brexit.
Assuming an outcome satisfactory to the myriad players in this game (a challenge in itself) lifting the current air of uncertainty, we would expect the Bank of England to raise interest rates, government bond yields to increase and the share prices of smaller UK-listed companies to outperform their larger counterparts.
How UK equities overall behave in absolute terms will depend on sterling’s ascent, how negotiations progress with our own trade talks and any further political instability.
We are currently underweight UK assets, but are prepared to revisit this depending on developments.
