The outcome of the Xi-Trump meeting at the G20 summit was moderately more constructive than our baseline scenario. Both sides agreed to restart trade negotiations while the final round of US tariffs was put on hold with no deadline mentioned.
Trump also surprised the market by reversing course on Huawei and indicating that some restrictions on Huawei would be eased ahead in exchange for Chinese commitments to purchase agriculture goods.
Given that the Huawei issue is the focal point of larger Sino-US tensions over technology and 5G dominance, this is a significant step in a positive direction although it is not clear how far Trump will go.
We believe Trump would not risk a political backlash at home by removing Huawei from the BIS Entity List, and a likely scenario is that the US would ease supply restrictions to Huawei through licenses or exceptions granted to Huawei’s US suppliers after the existing 90-day temporary general license expires in mid-Aug.
With this outcome from the G20 summit, the likelihood of trade escalation over the near term is substantially reduced. That said, as we had anticipated, this event was inconclusive in that both sides did not provide specifics on talk schedules or a timeframe for an agreement, and there was also no clarity about whether they had any discussions on the central issues of conflict, i.e., technology transfers, IP protections, market access and industry policies.
In its official statement after the G20, Beijing indicated that it must safeguard its core interests on issues relating to national sovereignty and dignity. Recalling Treasury Secretary Mnuchin’s recent comments that the Sino-US trade agreement is 90% completed, if the remaining 10% relates to these redlines of Chinese sovereignty and dignity, then it seems a fundamental gulf will continue to exist until one side makes significant concessions.
With no breakthroughs on key issues, we caution that the risk of the final round of US tariffs being implemented should this ceasefire end is a credible one (although the US would likely start with an initial low rate of 10%).
Before the G20, the futures market had priced in 100% certainty of a rate cut by July (76% odds of a 25bp cut, 25% odds of a 50bp cut). While these market-implied odds might slip marginally after the more positive than expected G20 outcome, our base case remains that the Fed will begin rates cuts in H2 2019, with the ECB (and possibly the BOJ) subsequently following suit with accommodative action.
All considered, this is a positive setup for risk assets over the near to medium term given the better than expected G20 outcome, prospects of central bank easing ahead against a backdrop of slowing but decent enough growth, and the limited likelihood of a recession over the next 12 months.
In terms of our asset allocation strategy, we are increasing our positions in US equities and Asia ex. Japan equities from neutral to overweight. Consumer confidence and spending in the US is holding up, while US equities earnings growth remains resilient in positive territory. The S&P500 consensus 2019E EPS growth of 2% seems achievable to us, and the 2019E price-to-earnings ratio does not appear demanding.
The G20 truce, lower rates, easing dollar strength as well as a more supportive growth environment will form tailwinds for Asian ex. Japan equities. Chinese policy makers have ample tools at their disposal to support economic growth, and lower US rates will further increase the scope for Chinese policymakers to implement monetary easing. Our preferred sectors in the Chinese equity market are those related to domestic consumption, infrastructure and construction, which should benefit as fiscal stimulus further accelerates ahead.Disclaimer applicable to recommendation
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