When will Brexit and the trade war end?
Potential turning points for the US-China trade war and Brexit could be positive for European equities.
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Two of the big political risks of the last 18 months appear to be entering a new chapter.
Phase one of the US-China trade negotiations saw both countries make concessions, cooling hostilities. Meanwhile, Boris Johnson was able to convince the UK Parliament to support his renegotiated withdrawal deal from the European Union (EU), substantially reducing the possibility of a no-deal Brexit.
These developments could benefit markets in different ways, but we’re particularly interested in the potential upside they might have for European equities.
Trade war cease fire
The progress between China and the US is modest, with agreements on Chinese purchases of US agricultural goods, and the US suspending its October tariff rises. But we think this could signal the end of the ‘escalation phase’ in the trade war.
The last 18 months have seen both sides announce increasingly punitive measures – not all of which have been enacted – in a battle fought as much in words as in deeds. This push and pull between the world’s two largest economies is what has disturbed markets.
The agreement, if confirmed, would be a sign that the tension is unwinding, which could be positive for equities. Even if there are no moves to reduce current tariff levels, an end to the gradual toughening of trade barriers would encourage investors.
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Finally, a deal
On Brexit, in the meantime, Parliament’s passing of Boris Johnson’s re-negotiated Withdrawal Agreement is another significant step to certainty. In particular, it greatly reduces the chances of a no-deal exit, effectively neutralising the binary deal/no-deal cliff edge. The rise in sterling this week – peaking at over $1.30, a level not seen for nearly six months – demonstrates market confidence.
But like the trade talks, the situation remains fragile. Mr Johnson faces opposition on some of the deal’s key measures – around workers’ rights and the customs border with Northern Ireland in particular – and we may see a general election before the end of the year.
There is also a lot of horse trading to be done with Europe around the final shape of a trade deal. But we think the likelihood of a no-deal outcome has greatly subsided and there’s a high chance that some variation of Mr Johnson’s Brexit deal will go through, before or after a potential general election.
Good news for Europe
Both these developments have one significant beneficiary for us – Europe. We’ve recently increased our exposure to European equity based on our view of the evolving business cycle.
As Lilian Chovin, Investment Strategist at Coutts, explains: “Our analysis of economic data indicates that the European economy could be heading for a recovery, having experienced a very sharp slowdown since 2018. Indeed, European equities have already shown a healthy positive move this year, and we think the upturn has further to go.
“While neither the trade war nor Brexit were decisive factors in our decision, both have had an impact on European equities; signs of a light at the end of the tunnel could see European equities get a boost.”
In the line of fire
Europe has been caught in the crossfire of the trade war in a couple of ways. Firstly, it’s been the direct target of tariffs, with President Trump imposing them on steel and aluminium in 2018 which hurt European exporters. Tariffs announced on car parts were later delayed, although the threat is still live.
Secondly, it’s been an indirect target (for tariffs) via its trading relationship with China, which is one of the region’s key export markets. As those tariffs reduce, the Chinese economy should improve, bringing increased export opportunities for European companies.
Lilian also suggests that an orderly Brexit would be positive for Europe. “Trade links between the UK and the continent are significant, and trade barriers were never going to be good news for EU companies,” he says. “A negotiated trade deal that avoids the disruption of a no-deal cliff edge should protect revenues for European exporters and therefore boost share prices.”
We expect to see continued support for economic growth from the European Central Bank as well. Outgoing president Mario Draghi, a key advocate for economic stimulus who once pledged to do “whatever it takes” to preserve the euro, chaired his last meeting this week. But we expect his successor Christine Lagarde to keep his supportive policies in place.
While an unexpected negative outcome on these developments could hurt sentiment, we think the improving business cycle and support from central banks should still be beneficial for European equities. Should they all come together, however, we could see them lift European equities even higher.
When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.
Recent events suggest that we’re about to see a change in direction on Brexit and the US-China trade war. These two political dramas have been weighing on investors for the last 18 months.
We are particularly interested in how these events might play out for European equities. A cooling off in trade war hostilities should provide an economic boost for China, one of Europe’s most important export markets, while an orderly Brexit will minimise disruption to important trade links with the UK. As we’ve recently added to our exposure to European equities, this could benefit our client funds and portfolios.
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