Wedding, war or extended engagement?

By Cássio Valdujo, V3

Market insights

Trade war, military war, cyber war. Is it even war? The US has participated in many armed conflicts throughout history, some of which are still active today. Paradoxically, the country has officially declared war only 11 times since its independence in 1776 - the last three occurring on the 4th June 1942 against Bulgaria, Hungary and Romania. What about Korea, Vietnam, the Persian Gulf, Afghanistan and Iraq, you may ask? Well, technically they were not wars at all, but were legally considered ‘extended military engagements’ - a way for US presidents to bypass Congress (the only entity with the power to declare war under the Constitution) to authorise military action.

When it comes to the US’s recent trade wars, a familiar pattern is revealed. To avoid complications and to jump the queue (Congress can be slow) Trump has issued executive orders as a means of moving his tariffs agenda forward. As a result, maybe we should adapt our vocabulary when discussing the so-called trade war between the US and China, instead terming it an ‘extended economic engagement’, or something of the sort, but not a war. Not unless Congress says so. And with Trump’s machine gun firing in all directions, from Mexico to the EU and from Japan to China, there is no way one could expect Congress to back him, let alone lead a march to impose tariffs any time soon.

Whatever you call it, the risk of a fully-fledged economic battle between the US and China reached its highest point yet in May. This is despite the fact that months of negotiations had reportedly left both countries on the brink of an agreement - at least until the end of April, that is. Who is to blame for this sudden rise in temperature? We might never know for sure, but the results were quite easy to predict, and markets suffered accordingly with higher volatility and losses across the board:

  • Developed market equities had their worst month this year as the US and China exchanged accusations, threatened more tariffs and hinted at a prolonged conflict instead of a negotiated agreement. The S&P500 lost 6.58% in the United States and the STOXX Europe 600 lost 5.70%, while in Japan, the Nikkei 225 fell by 7.45% as mixed economic data added concerns that the country is ill-prepared to weather the trade war between the US and China.
  • Fixed income markets had a month of mixed results. Safe havens bounded into positive territory thanks to renewed interest from investors, while lower-quality credit suffered strong losses both in the US and Europe. US Treasuries jumped 2.33% and US investment grade bonds gained 1.43%, while US high yield bonds ended the month down 1.19%. In Europe, sovereign bonds gained 1.09%, with 10-year German bunds reaching their lowest yields in history (-0.20%), while investment grade bonds lost 0.15% and European high yield bonds lost 1.35%.
  • Emerging markets had a mixed month, with gains in bonds supporting both lower yields in US Treasuries and losses in equities (in line with the broad market). EM equities lost 7.53%, while EM bonds gained 0.62%.
  • Oil had a disastrous month following the so-far failed trade agreement between the US and China and flirted with a bear market after falling by 16.29%.
  • Gold had a positive month, gaining 1.71%, as a result of strong demand for safe havens in general. The possibility of an interest rate cut in the US and the risk of higher inflation (due to tariffs related to the so-far unsuccessful trade talks between the US and China) should keep the yellow metal well-sought after for the near future.

Global markets in numbers


Market Outlook and V3´s position

Trump’s strategy to bring a howitzer to the fight, instead of a handgun, was a rude awakening and a reminder of the uncertain times we are currently living. It left little doubt that the trade-war thematic is here to stay and that, in contrast to how it was deceitfully portrayed by both parties in the weeks leading to the talks’ break down, a deal is a long way away. May marked the break in the bull run and, for investors suffering from FOMO, released them from their ‘fears of missing out’ by showing that sticking to one’s guns can sometimes be the best decision.

The reaction of the Chinese to the latest US provocation (which in turn was a reaction to an apparent last-minute change of stance from the Chinese negotiators) was enough to send markets spiralling down uncontrollably and almost nothing, bar safe havens, was spared in this process. The latest events also put both countries in a much more difficult situation going forward, by potentially killing the possibility of a save-face agreement (albeit perhaps an empty one) that could have been signed months ago and taken as a victory by both camps. As the threats escalate, even returning to the previous status-quo now seems like a herculean task, as it would mean finding a way to show to your constituents that you are not making too many concessions to the other side. A complicated situation for Trump to be in as we approach the US Presidential elections in 2020.

To reduce the risks, some familiar faces will likely reclaim the stage. Once again, central banks are expected to be the bastions of the markets, acting to avoid deeper economic contractions from the fallout of the trade talks, as well as from any additional tariffs applied to other US trade partners. This time, the problem is that central bank fire-power is quite limited compared to when they came to rescue markets after the 2008 financial crisis. Apart from refraining from tightening financial conditions in Europe and Japan, and probably cutting interest rates a couple of times in the US, there is little more they can do. How much and for how long they could support markets remains to be seen, but so far, the mere expectation that they could indeed do something is enough to limit the negative sentiment that news headlines have been fuelling day after day.

We adopted a more cautious approach in our portfolios in May. Despite the potential for a market recovery, supported by a hypothetical rate-cut by the US Federal Reserve, we believe it is more crucial to protect investments. This includes increasing the allocation to defensive equity sectors, focusing on credit quality, choosing companies with a strong cash-flow generation and industries that are less dependent on foreign trade and so are less likely to be impacted in case of a full-fledged trade war between the US and China. We insist on keeping cash at hand in case of a strong market reaction which causes prices to fall dramatically, but we are not in a hurry to use it. If there is a war coming, our soldiers are ready.

For more information, please contact our Chief Investment Officer, Cássio H. Valdujo, on:

+41 22 715 0910

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