Equity Monthly: Light at the end of the tunnel?

January was a big comeback month for global equities, which rose 7.8% in the wake of Federal Reserve chair Jerome Powell's significant U-turn on January 4, when he acknowledged that the Fed was open to ending quantitative tightening faster than anticipated and stated that the current interest rate trajectory was put on hold.

Immediately thereafter, the Chinese government enacted several key stimulus programmes, from cutting taxes to cutting interest rates and banks’ reserve requirements. While global equities have responded positively to these events, Chinese investors are still holding back. Key levels in the CSI 300 Index (China’s leading stock market index), however, may soon be broken to the upside which could change the dynamics altogether. From our sources in China, sentiment has changed for the positive lately which will likely drive risk-on sentiment in equities but hard economic data will not show the change until as late as Q4 this year.

The crucial thing required if the economy is to avoid slipping into recession is more monetary stimulus (most likely to come) and a comprehensive US-China trade deal. We use the USDCNH exchange rate as the best proxy for estimating the probability of a trade deal, and the signal here is clear: a trade deal is coming. We put the probabilities at 25% (no trade deal) and 75% (trade deal). But what's more important is the nature of the deal. Will it be comprehensive or not? If it is not comprehensive, the market's reaction will likely amount to a short-lived rally and then a fade. If it is comprehensive and China has responded forcefully enough against its economic slowdown then equities could fight back to new all-time-highs.

What we hear from sources in China is that the two parties (US/China) are moving closer to each other but some key bottlenecks remain in place. Ultimately, however, the process is most likely so advanced that the deal will be extended (the current deadline is March 1). Two things stand out: first, the US wants China to close the trade deficit gap much faster than China can accept given the impact on its economy. Second, this trade deal is highly bilateral, circumventing the World Trade Organisation and in this way potentially representing a new chapter in globalisation. It could potentially represent a new chapter in the globalisation process, and one based more on national interest than is the contemporary norm.