The US and China are so close to a trade deal that “a formal agreement could be reached at a summit between President Trump and Chinese President Xi Jinping, probably around March 27, after Mr Xi finishes a trip to Italy and France,” The Wall Street Journal reported on Sunday.
Evidently President Trump wants a trade deal before the evident weakening of the US economy in the first quarter becomes a declining trend, hurting his prospects for reelection in 2020. The decline in world trade during 2018 of -2.1% in terms of import volume is largely the result of the US-China tariff war. It hurt damaged economies heavily dependent on trade more than it did the United States, but now the US is showing signs of weakness. First-quarter growth is projected at just 0.3% by the Atlanta Federal Reserve’s widely followed GDPNow model. Ominously, the US consumer, the mainstay of the long US recovery, is showing signs of caution.
Prospects for a resolution of the trade war as well as indications that China’s stimulus will keep the country’s growth above 6% led to sharp gains in Chinese stocks last week, as well as strong gains in European markets. The S&P 500 by contrast has been treading water for a week as investors take their bearings after the January rebound. For the time being, I expect China and Europe to repeat their February outperformance of the S&P in March.
As I observed on March 1, market leadership by China’s financial sector is a very good sign. The life insurance companies and brokers led gains, a sign that investors expect not only a stabilization of the Chinese economy but also an expansion of China’s still-primitive capital markets and high future earnings by financial companies. New China Life was the best performer on the Han Seng China Enterprises Index during the past month with a gain of 23%. But the H-share is still selling at just 14 times earnings, half of its September 2017 peak.
Otherwise, some of the European industrials with high exposure to China are an inexpensive way to gain Chinese exposure. The chart below shows the members of the EuroStoxx Index with the greatest sensitivity to the Chinese market (using the China MSCI Index as a benchmark).
Top of the list is MC (Moet-Hennessy Louis Vuitton). It’s pricey at 24 times earnings. So is German software maker SAP at 27 times earnings and Dutch semiconductor equipment maker ASML at 26 times earnings, although ASML well may merit the high multiple. Volkswagen at less than 7 times earnings, though, is a bargain; half the automaker’s earnings come from China where it is the most popular nameplate.
US forecasters were blindsided by a sharp drop in consumption during December, which they blame on the end-of-year stock market crash and a government shutdown. A week ago the Commerce Department reported the worst drop in month-on-month retail sales in seven years, and the forecasters blamed bad data. On Friday, though, the government reported the sharpest drop in personal spending in the past seven years, corroborating the retail sales number.
I have been arguing for a year that the US household sector is far more fragile than the robust employment numbers might indicate. Average hourly pay gains are coming in at 3%, which amounts to a roughly 1% real increase. After twenty years of stagnating household income, though, the pay increases generated by the present recovery seem like rounding error. It has been widely noted that credit conditions are tightening for consumers. The consumer balance sheet is improving, but that is in part due to banks’ reluctance to provide mortgage or revolving credit to all but the best-rated American borrowers.
A number of US analysts point to the apparently high contribution of nonresidential fixed investment to fourth-quarter US economic growth, according to the preliminary estimate released last week. I published the chart below previously, but the point bears repeating: the sort of investment goods that typically drive growth, industrial and information processing equipment, showed declines during the fourth quarter. Most of the gain in fixed investment took the form of intellectual property.
It’s not clear what this involves: It could reflect US tech companies transferring IP from foreign subsidiaries to the US, for example. The report is unconvincing, and probably subject to considerable revision.
Federal Reserve survey data suggest that US corporations will reduce CapEx during 2019. Morgan Stanley analysts combined the capital expenditure plans survey data for the various US Federal Reserve districts into a single index, which shows a significant downturn for the next six months.
