LONDON : Markets may have hit “peak fear” when it comes to the threat of a trade war between the US and China, and will react less aggressively to future developments as a result, analysts at the Swiss lender UBS argued on Monday.
Writing after a week in which European equities fell sharply before rallying, a team of strategists led by Nick Nelson and Karen Olney argued that attention given to trade had most likely reached its highest point and should subside, with markets refocusing themselves on the fundamentals of Europes recent growth.
“The threat of trade wars is another concern driving equities,” the team said in a note dated Monday. “There is little clarity at the moment, but media coverage suggests we may have hit peak fear.”
Equity markets dropped sharply early last week after the US and China exchanged tit for-tat announcements of plans for tariffs on hundreds on billions of dollars worth of goods. European stocks dropped as much as 1.5 per cent during trading on Wednesday.
Those concerns have hit Germanys stock markets the hardest, given that it is Europes biggest economy and relies heavily on exports.
“Within Europe, Germany has underperformed recently — the DAX is down 9.3 per cent from the 23-January peak and has underperformed the Euro Stoxx 50 by 2.7 per cent YTD,” the UBS team said.
“This may be because of concerns about the exposure of the economy and the stock market to global trade and some of the potentially exposed industries, such as steel and autos.”
Volatile actors like President Donald Trump make it difficult to form market predictions, so investors tend to assume the worst-case scenario following negative developments (i.e., a full-blown trade war) and the opposite when there are positive developments. This can create big swings in market prices. “Equity markets tend to struggle to price in the small probability of a very negative event occurring,” UBS said.
“If we were to see an all-out trade war between the US and China, with the EU involved as well, it could lead to dramatically lower global trade and ultimately, a sharp economic slowdown. However, it is not clear that is the most likely path from where we stand today.”
The analysts point to the fact that while announcements have been made, there has been no real substantive action so far – the direct impact of the skirmish has been fairly inconsequential.
“To date, the direct effects of the measures have been relatively minor (UBS expects a c.10bps drag to Chinese GDP) with many potential exclusions on the US side and a proportional response from China,” the analysts said.
They urged caution, however, noting that “this is clearly a live issue though with further comments from the US administration on Thursday.”
“Certainly the media coverage of trade wars appears to have hit a multi-year peak,” they added. With the market hitting “peak fear” of a trade war, UBS said, European investors are soon likely to refocus their attentions on what appears to be the slowing momentum of the continents economic growth. A series of weak PMI data last week has sparked concerns, with UBS noting that European equities “are now down 6.6 per cent from their January peak and down 3.4 per cent year to date.” UBS continued: “The initial sell-off was driven by higher inflation and sharply rising bond yields. But that has now morphed into concerns over PMIs rolling over.”
Investors shouldnt be too worried, however, with the team arguing that “the level of the PMIs are still high (the composite PMI is 55.2) and suggest strong economic growth.”
“In Goldilocks terms, the fear is now that the porridge is not too hot, but too cold,” UBS said.