Meet Me in St. Louis?
Bottom line We have admittedly been more constructive than most on the chance of a U.S.-China trade deal coming to fruition before the end of 2019. To that end, we’ve had two important dates circled on our calendar: Oct. 10 and Nov. 17.
Oct. 10 was the 13th round of bilateral trade negotiations in Washington, D.C., where Treasury Secretary Mnuchin and trade representative Robert Lighthizer met with Chinese Vice Premier Liu He to reboot the trade talks that derailed last May.
The next planned step was to be on Nov. 16-17 at the Asia Pacific Economic Cooperation (APEC) Summit in Santiago, Chile. Presidents Trump and Xi were both scheduled to attend. They were expected to meet privately and potentially sign a so-called “Phase One” trade agreement, in which the U.S. would exchange some tariff relief for accelerated levels of desperately needed agricultural and energy exports to China.
But the recent violent protests in Chile prompted its president, Sebastian Pinera, to cancel the APEC Summit, as well as a United Nations climate summit in early December.
This logistical setback has thrown a monkey wrench in a potential signing ceremony, as the Trump administration is now scrambling to find an alternative venue. The U.S. has proposed Washington, D.C., Iowa (symbolically in the heart of farm country) and either Alaska or Hawaii (they’re closer), but all such state-visit sites have been rejected by China. So Trump then suggested Sweden or Switzerland (they’re neutral), with a possible eye on London, site of the 70th annual NATO Summit on Dec. 3-4. However, as our research friends at Evercore ISI point out, the location of the meeting is less important than the key date of Dec. 15 when the next round of U.S. tariffs are scheduled to go into effect.
Our first objective with these trade talks has been to do no more harm, so both nations must find a way to avoid escalating the tariffs and inflammatory rhetoric next month. Consequently, we expect some positive resolution to this situation over the next several weeks, which has coaxed a powerful 8% rally out of the S&P 500 since Oct. 3, to within a hair’s breadth of our long-standing 3,100 year-end 2019 target.
The alternative is ugly This trade dispute has been going on for 19 months, and there’s little question in our minds it’s had a deleterious impact on U.S. economic growth. The reduction in corporate CEO confidence this year has resulted in less capex spending. This has caused productivity to slip, leading to slower economic and corporate-profit growth. Witness the following key metrics:
- NFIB small business optimism index Hit a 44-year high of 108.8 in August 2018, but fell to a 9-month low of 101.8 in September 2019.
- Conference Board’s consumer confidence index Reached an 18-year high of 137.9 in October 2018, but fell to a 5-month low of 125.9 in October 2019.
- ISM manufacturing index Hit a 14-year high of 60.8 in August 2018 but fell to a 10-year low of 47.8 in September 2019. October perked up to 48.3.
- Corporate capital expenditures (capex) After a robust 11% quarter-over-quarter (q/q) increase in the second quarter of 2018, corporate spending on structures has fallen in four of the last five quarters, plunging 15.3% in the recent third quarter of 2019.
- Productivity declined from a 1.8% year-over-year (y/y) gain in the second quarter of 2019 to a 1.4% y/y increase in the third quarter. Productivity actually fell, 0.3% q/q, for the first time since 2015.
- U.S. GDP From a robust 3.5% q/q gain in the second quarter of 2018, the GDP growth rate slipped to 1.9% in the third quarter of 2019.
Both sides need a deal Chinese GDP growth in the third quarter at 6% y/y is its slowest pace in 27 years, and at 49.3, October manufacturing PMI has been in contraction territory for the past six months. In addition, China needs to stem the tide of supply-chain departures out of the country and find a peaceful resolution to the Hong Kong protests.
The U.S., on the other hand, is hoping to halve its $400 billion annual trade deficit with China, with stronger exports of agricultural products, energy, semiconductors, as well as auto- and aerospace-related products. In a $21.5 trillion U.S. economy, an additional $200 billion in annual exports to China could boost GDP nearly 1% (all other factors remaining equal), which could boost Trump’s bid for re-election.
Comprehensive structural reforms later We believe that this so-called “Skinny Deal” will come soon, but it will not resolve the thornier structural issues that remain at the heart of this dispute. These include theft of U.S. intellectual property, forced technology transfers from U.S. companies to Chinese companies, Chinese currency manipulation and the U.S. tariffs on Chinese goods. We expect discussions will continue over time, but we don’t have any illusions about a near-term fix prior to the 2020 presidential election.