China and emerging markets are likely to be the biggest beneficiaries of the Phase 1 trade deal.
Ink has now dried on the Phase 1 trade deal with China, but investors who expect the removal of uncertainty to fuel additional U.S. growth may be disappointed.
Markets ran up ahead of the signing, and investor enthusiasm remains strong, but I don’t expect the deal to provide much lift to the U.S. economy. Instead, the deal, plus global central bank easing, should propel a recovery in international trade and manufacturing that was already underway. Those improvements may have largely been priced into U.S. stocks at this point while China and emerging markets are likely to be the main beneficiaries of future trade-related growth.
Below are three reasons we don’t see the deal contributing to much additional upside for U.S. stocks:
- China’s targets for U.S. imports seem ambitious. One reason investors have been excited about Phase 1 of the deal is that it calls for China to increase its imports of U.S. goods by $200 billion. However, when our analysts drill down into industry targets, we find that many of them seem unrealistic and enforcement mechanisms are limited.
- Existing China tariffs remain in place and U.S. policy makers could potentially seek more in Europe. The costs of tariffs are typically passed onto U.S. consumers, creating headwinds to economic growth. Remaining Chinese tariffs slow U.S. GDP growth by about half a percentage point, the Federal Reserve estimates. Our strategists believe an additional headwind from trade is possible this year coming from escalating trade tensions with Europe, now that U.S. policymakers seem to see tariffs as an effective tool.
- This phase of the China trade deal doesn’t resolve uncertainty around issues that may be inhibiting capital spending. The key issues with China that seem to most concern CEOs involve intellectual property and technology, and those discussions have been pushed off to the next phase of trade talks. That’s a big reason we remain skeptical that this will stimulate much additional capital investment.
The main impact of the trade deal, in my view, has been to put further escalation of trade tensions with China on hold for the next six-to-nine months. That, plus the stimulus added by global central banks, should support a global economic recovery, which is already underway.
In China and most emerging market countries, trade is a bigger part of GDP than in the U.S. That makes those economies more leveraged to improvements in global trade than the U.S. and bolsters the case in our 2020 investment outlook that this is a good year to emphasize non-U.S. stocks.
I suggest investors look to reinvest some of their profits from U.S. growth stocks and index funds into non-U.S. equities. Many large-cap U.S. growth stocks currently have high valuations and may be vulnerable if economic or earnings growth disappoints. Consider emphasizing emerging markets, which may be the biggest beneficiaries of improving global growth and easing trade tensions.