Size Matters

Oct 15, 2019 | Dann Cushing


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In the last update, we proposed the following key question for financial markets: ...

...will a US-China trade deal occur quickly enough to avert an otherwise impending recession? After Friday’s news on this front, a more short-term question has emerged: does a mini-deal between the US and China count? 

 

To help answer this, a few observations:

 

1. The terms of the deal involve agricultural purchases by China – along with some token measures on currency and intellectual property – in return for the US not increasing tariffs by 5% on October 15;

 

2. The concessions by China are similar to what they originally offered in May, while the US is conceding something that didn’t even exist until they created it 60 days ago; and,

 

3. The exact terms of the deal are in fact not finalized, but instead are to be hammered out over the coming month.

 

In summary, this deal is arguably the smallest between the two countries that could still be deemed newsworthy. No tariffs have been repealed; no fundamental changes have been made to China’s industrial strategy. For even the casual observer, this mini-deal feels like it is more about temporarily “changing the narrative” from other political hot-topics than it is about genuine progress for trade relations between the two countries.

 

Recall that the threat of a full-blown recession hinges on whether the current slump in global manufacturing triggers a feedback loop, where falling business confidence ultimately transmits to the otherwise stalwart US consumer. Predicting the perceptions of individuals is difficult, but it seems fairly intuitive that a Fortune 500 management team currently planning for 2020 will not gain adequate confidence from Friday’s mini-deal to suddenly increase next year’s budget or profit outlook. 

 

This particularly important right now since the Q3 earnings reporting season will begin this week. Not only will management teams provide results for the past quarter – a period that will include broad “List 4” tariffs for the first time – but many companies will also provide at least a directional outlook for 2020. With equity markets near their highs, valuations above average and Street expectations of 10% earnings growth next year, a less-than-confident business environment poses some obvious risks to equity markets.

 

While all of this reads fairly logically, it is important to note that for now financial markets disagree. The mini-deal could in theory morph into a much broader one. The concerns above might never ultimately transmit to the consumer given what appears to be new, structurally lower levels of unemployment in developed countries. Last-minute progress on Brexit is also adding to a general feeling of tension relief (we’ll believe that when we see it). For now though, these remain rather hopeful outcomes while the contraction in global manufacturing and business confidence is a current reality that Friday’s mini-deal is too small to change. Financial markets are probabilistic, and the balance of probability still seems notably weighted to the downside.