Key Points from around the globe
1. US and China
Markets suffered on Monday morning, after President Trump issued fresh threats of increased tariffs on Chinese goods, sending S&P futures down 1.5% through the 2900 level. The new threats include an increase from 10% to 25% on the previous $200Bn of goods, and new proposals of 25% on an additional $325Bn. The Shanghai stock market is down over five and a half percent and the Yuan is seeing pressure. We believe this is just a re-flare up of rhetoric by the US and our base case remains for a trade deal which favors both parties to get done however we cannot rule out a deadline extension past this Friday, to which we believe markets will react favorably. The risk of talks breaking down still lingers though, and in the unlikely event that these new tariffs get implemented on Friday, we expect Chinese and US stock indices to feel significant pressure with spillover to other markets. China’s foreign ministers are traveling to Washington on Wednesday to continue the talks. Economic estimates say that tariffs at current level add a 0.5 percentage point blow to Chinese GDP. An increase to 25% on $200 billion of goods would push this number to 0.9 percentage point. Tariffs on ALL Chinese Exports to US would increase the drag to 1.5 point. The risk off sentiment triggered by this news sent Treasuries higher. On a upbeat note, US jobs data on Friday was very healthy though showing signs of peaking. The bulk of earnings season in the US has passed, printing an unimpressive 1% quarter on quarter growth overall.
Credit spreads are reaching their post-crisis tight levels. We believe the recent tightening is purely momentum driven. We expect modest spread widening going forward especially in the lower rated names and we see future returns being driven mainly by carry. People argue that post the crisis debt levels have again soared in the corporate space however if one looks into the metrics, one would see that debt as a percentage of corporate cash flows (a measure of liquidity) and debt as a percentage of assets (a measure of solvency) is lower than it has been in the previous two decades. This is also due to the increasing consistency and stability of corporate cash flows over time. Lower interest rates have also encouraged firms to take on more debt as interest expense remains manageable. We think that the lack of further spread tightening well be primarily due to, headwinds in corporate margins given the time of the cycle and, any scope for Fed rate cuts being pushed further out and this may present an opportunity to pick up some strong credits at more attractive levels.
Crude has seen continued selling with Brent oil settling around the $70 level after peaking at $75 a barrel. The fundamentals however remain supportive for oil. We think the market will remain undersupplied for the rest of the year and crude will be well bid, giving a chance to enter into oil related names that have sold off recently.