Acumen’s Q3 2018 Market Insights Commentary
One of the challenges of investment management has always been filtering out the ‘noise’ and focusing on important economic and market issues. This challenge is exacerbated by the fact we are living in an incredibly noisy time. One issue to review is the trade talks. While the nitty-gritty of trade is important for investors, it is always useful to keep in mind what is happening with economic fundamentals. U.S. growth is still strong and there is no sign trade tensions are causing a drag on economic growth or surge in consumer prices.
Keeping track of the state of U.S. trade has been a full-time job for investors. Both proposed and implemented tariffs, as well as tentative agreements, have all been changing week by week. Canada joining in on a post-NAFTA agreement, dubbed the United States-Mexico-Canada (USMCA) agreement, was a significant positive development. Markets breathed a sigh of relief following the trilateral trade deal with U.S. stocks rising after the announcement.
Striking an agreement with the Chinese is proving to be more difficult. As long as the issue with China remains about tariffs and trade, it is manageable. But the situation could become more troublesome if it fundamentally becomes an economic battle between the two largest countries in the world. As trade tensions continue to rise between the U.S. and China, investors are concerned with how China might retaliate. One theory is China may look to sell its $1.171 trillion dollars of U.S. Treasury holdings, with the intent of forcing yields higher and raising borrowing costs in the U.S. However, this outcome seems unlikely. Global central banks hold foreign exchange reserves for several reasons, most prominently for currency management purposes. Equally, the depth, credit quality, and liquidity of the U.S. bond market provides the Peoples Bank of China with a pool of safe-haven assets that can quickly be sold to stabilize its own currency. If China were to sell its U.S. Treasury holdings, it would need to find another source that could provide the same liquidity and yield, something which isn’t currently available in the global economy. In addition, China owns much of its foreign currency reserves in USD. By selling U.S. Treasury holdings, it would, in effect, deplete its dollar holdings which could result in upward pressure on the yuan. China is still heavily dependent on trade (accounting for roughly 19% of its GDP), and a stronger yuan would make its goods less attractive to global buyers. While other factors may push the yuan in either direction, we believe China is unlikely to sell U.S. Treasury holdings in retaliation, but, instead, turn its attention to U.S. business operations in China.
There is a risk trade tensions and political turmoil may result in a slowdown in global growth. Overall, while trade tensions do require watching, they are not currently an impetus to get out of the market, but, rather, a reason to be thoughtful in how we allocate portfolios across global markets.
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