June saw equity markets around the world give back some of the gains made in April and May. The trigger for these falls appeared to be the resurfacing of fears over a global trade war. China responded forcefully to US president Trump’s threat to impose tariffs on $200 billion of Chinese goods, vowing retaliation of some sort. Trump’s tariffs affect Europe too, and the European Commission itself raised the temperature by saying it could impose tariffs on $300 billion of US products.
"Instead of Smoot-Hawley, we may be looking at a version of the Plaza Accord"
Where this all ends is hard to say. The global trade war of the 1930s helped cause a severe depression that contributed to the real war that started at the end of the decade. There are of course major differences between then and now. In the first half of the 20th century, economies were much simpler, and largely based on primary industries. Nowadays, on the other hand, the global supply chain is highly complex, with a high degree of division of labour on a national scale.
So arguably, a trade war now would be much more damaging.
That said, the United States’ trade deficit is unsustainable, so must be addressed at some point. The question is, is Trump going about it the right way? In many respects, the US trade deficit is less about unfair trade practices and more about the behaviour of Americans themselves. Americans choose to live beyond their means, which naturally results in a large trade deficit. Imposing tariffs is a bit like someone suffering from obesity telling supermarkets to put their prices up, rather than addressing the root of the problem, whether medical or relating to addiction.
Although Trump’s rhetoric appeals to his electorate, it may well be that he is hoping to force China to the negotiating table rather than start a trade war. The reality is that China’s trade surplus is as unsustainable as the US’s deficit, and the US has an interest in how its creditors might behave. So, instead of Smoot-Hawley (Tariff Act of 1930), we may be looking at a 21st century version of the Plaza Accord, whereby surplus countries such as China agreed to appreciate their exchange rates against the US dollar. This would be far more preferable to a trade war, or indeed a real war.
On the domestic front, the Bank of England’s Monetary Policy Committee voted 6-3 to leave the base rate unchanged at 0.5%, though notably chief economist Andy Haldane defected to the Hawks. Following the news, markets quickly priced in a much higher likelihood of a hike at the August meeting.
In the US, the Federal Reserve voted to raise its benchmark interest rate by 0.25% as expected. More importantly, the guidance from the Fed appears to be that there will now be four hikes this year not three. Both Haldane’s defection and the changed guidance from the Fed support our view that the global economy continues to strengthen and that inflation pressures continue to build.
Elsewhere on the economic front, unemployment rates fell in the US and Japan and remained steady in the UK and Europe. As for inflation, core CPI inflation in the US rose again and now sits at 2.2%, well above the Fed’s 2% target.
In terms of financial markets, as mentioned, equity markets were weak on the back of rising trade war fears, with emerging markets particularly hit. Bond yields, having fallen at the end of May, in general fell a little further in June. It may be of interest to note that since their peak in 2016, Gilts have returned -9% in real terms. So much for being a safe haven asset!
As for fund activity, there were no major asset allocation changes during the month. We lowered equity targets at the end of May and plan to lower them again at the end of July, in line with our roadmap of a reduction every two months as we progress towards the end of the investment cycle.
Looking ahead, there has been no reason to change our view that inflation pressures continue to build and therefore that central banks will need to continue to tighten monetary policy. Low unemployment is likely to mean that wages across the developed world will continue to accelerate, maintaining the upward pressure on inflation. Thus we expect cash to gradually become more attractive over the next couple of years, with a commensurate decline in the attraction of business investment as well as investment in financial assets such as equities.
Published in Investment Letter, July 2018
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.