Last weekend, in a post for this platform, I noted how remarkable it was that US equities managed to shrug off the biggest oil supply disruption in history and the worst short-term funding squeeze since the crisis, only to falter at the first sign of trade trouble.
A week ago, the problem was an unexplained itinerary change by Chinese trade negotiators, who inexplicably canceled plans to visit US farms in Montana and Nebraska following working-level discussions with US officials.
For those who need a refresher, here is what happened last Friday when news of the canceled farm visits crossed (incidentally, it turned out that the US side nixed the trips in order to “avoid confusion”):
Fast forward a week, and it’s déjà vu all over again. Another foreboding trade headline took a bite out of risk assets which otherwise may have coasted peacefully into the weekend. Have a look:
As the annotation indicates, the proximate cause of the midday swoon on Friday was a bombshell Bloomberg scoop detailing discussions within the Trump administration, where officials are debating ways to curtail portfolio flows into China.
There are a variety of proposals under consideration, including “delisting Chinese companies from U.S. stock exchanges, limiting Americans’ exposure to the Chinese market through government pension funds [and] putting limits on the Chinese companies included in stock indexes managed by U.S. firms.” Nothing is final, and the logistics around some options have not been worked through.
Needless to say, this was not good news for the likes of the iShares China Large-Cap ETF (FXI) and the iShares MSCI China ETF (MCHI). It was even worse news for Alibaba (BABA), which flat-out plunged.
To be frank, it’s somewhat odd that US equity benchmarks didn’t suffer even bigger losses than they did. I’m writing these lines with 45 minutes to go until the bell, and the S&P is off less than 1%.
It is not a stretch to characterize this latest twist in the US-China trade war as a potentially disastrous turn for the worse. Irrespective of the rationale behind the push (which has fairly broad-based support and is ostensibly aimed at addressing a list of legitimate US concerns), were the administration to move ahead with any of the proposals mentioned above, it would have sweeping implications with the potential to far outweigh the fallout from the tariffs alone.
Bloomberg writes that going down this road “would have repercussions for billions of dollars in investment pegged to major indexes.” That is an understatement and doesn’t even begin to capture the potential second-order effects.
There are more than 150 Chinese companies listed on America’s largest exchanges. Their combined market cap exceeds $1 trillion. Forcibly delisting those or, worse, attempting to orchestrate index shakeups by executive decree, is an almost unfathomable prospect. Even if you could argue that it’s feasible and justified to protect domestic investors from murky Chinese corporate structures and ensure Americans aren’t funneling capital to a country that is in open economic conflict with the US, such a move would almost certainly derail the trade talks, only for good this time.
In addition to that, Beijing would surely respond. In the wake of the news, commentators were quick to parrot the line about it being counterproductive for China to weaponize its hoard of US Treasurys. There are, of course, myriad reasons why Beijing has never been keen on going that route, but the kind of financial broadside inherent in the proposals Bloomberg says the Trump administration is considering would call for something bigger than a “measured”, “rational” response. As the old adage goes, desperate times call for desperate measures, and just about the last thing the US needs when Treasury is flooding the market with supply to finance the deficit, is for China to pull its support for the market.
Before we get too far into the realm of hypotheticals, let’s just bring it back to what’s true right now. We don’t know if any of the ideas under consideration by the White House will ever reach the implementation phase, and even if they did, the day of reckoning is some ways off.
But this story is now “out there”, as it were. And probably not by accident. Bloomberg’s account is lengthy and their cadence does not suggest that the story is in any way speculative. In other words, it could very well be that the White House is fine with this being in the news on the assumption it gives Bob Lighthizer and Steve Mnuchin leverage ahead of principal-level trade talks with Chinese Vice Premier Liu He starting on October 10.
This comes as China recently ramped up purchases of US farm products, including soybeans and pork, a goodwill gesture to President Trump. Bloomberg says Washington “has not had any discussions with the Chinese government” over this, which, if true, opens the door to Beijing seeing it as a threat (and a rather grave one, at that) and an attempt to put Liu under the proverbial gun during the new round of talks. The Chinese have repeatedly implored the US not to make threats ahead of negotiations and this latest news comes at an extremely sensitive time politically, with China set to celebrate the 70th anniversary of the PRC.
If talks break down again, it could deal a grievous blow to the sputtering global economy and to fragile consumer sentiment in the US.
On the former point, Barclays reminds you that “despite recent encouraging noise on US-China trade talks, there are more tariffs in place than three months ago, every major economy is seeing a full-blown industrial/ manufacturing slowdown [and] global trade volumes continue to fall.”
Those charts go a long way towards explaining why the bank shifted to a defensive stance (overweight fixed income versus equities) in their new global outlook piece, released on Thursday.
On the point about US consumer confidence, note that although the final read on September University of Michigan sentiment represented an uptick from the preliminary read (and a decent bounce off the August Trump-era nadir), the survey found consumers back to mentioning the trade war, unprompted, with record frequency, when elaborating on their outlook for the US economy. More simply: Tariff angst is running high after the August escalation.
Although the consumer showed up for President Trump in August according to the latest retail sales data, Friday’s read on personal consumption for last month was less sanguine, printing the lowest since February.
It likely wouldn’t take much to spook Americans anew on the trade war, especially considering the fact that, as Goldman reminds you, “the Trump White House has never reduced any major tariffs on imports from China once they have been imposed and most of the tariff increases that the White House has previously proposed have indeed occurred.”
With that in mind, I would point out that just hours after the Bloomberg story rippled across markets, Chinese foreign minister Wang Yi said his country will “not be cowered by threats.”
“Tariffs and provocations undermine the global economic order,” he said, at the UN General Assembly in New York, adding that “they may even plunge the world into a recession.”
When the closing bell sounded on Wall Street, US stocks had fallen for a second consecutive week.
I’ll give the last word to my good buddy Kevin Muir, formerly head of equity derivatives at RBC Dominion and currently head of research of global and domestic investment products at East West Investment Management, who on Friday had a simple message for market participants:
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.