US-China escalation could result in equity correction
We have always maintained a failure from the US and China to find a way to agree on trade is the only genuine threat to economic growth in 2019.
If reports are correct, the current breakdown in negotiations has been caused by a fundamental and difficult sticking point. US trade representative and long-time China hawk Robert Lighthizer has been leading the demand for China's concessions on trade policy to be reflected in changes to Chinese law. This would make any new agreement easier to enforce and more likely to survive beyond the current US administration. There may have been some progress towards this goal, but it appears President Xi Jinping himself led the pushback.
An escalation of tariffs does not necessarily mean an end to negotiations and any hope of a deal. Indeed, our view is this is very unlikely. Both sides can make space to climb down into, but it will take more than a couple of days and it will likely be done against a background of higher tariffs.
This means more weeks and months of uncertainty for investors on a matter they had started to price out of risk assets. Ultimately, we would not be surprised to see this translate into the loss of half or more of the gains equities have enjoyed over the first four months of the year. This would put the S&P 500 into correction territory.
Credit markets will feel the pain too, but we think they may be less vulnerable, due to valuations, moderately good first-quarter earnings lifting fundamentals and an improvement in market technicals and liquidity since the big sell-off in December.
The picture could certainly get worse. However, the ultimate goal of settling on a durable deal is clearly in the best interest of all. We are likely in for a rough ride over the summer, but it may be an opportunity for nimble investors to find some much-needed value.
Brad Tank, fixed income CIO at Neuberger Berman
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