It has been one of the pronounced paradoxes of this market: the harder Trump pushes and escalates trade wars with various opponents - mostly China - the more the market rewards him by setting new all time highs, leading the president to believe he is "winning" and resulting in even more aggressive future escalations. Perhaps as a result, earlier today Goldman said that following Trump’s threat of further escalation in the trade war with China, the bank now thinks the probability that all imports from China will ultimately be subject to tariffs has risen to 60%.
And, in a note from JPMorgan's strategists over the weekend, the bank expressed a similar - if even more nuanced - concern, warning that it is starting to make "forecast and strategy changes" around issues emerging from the US-China conflict.
One is the growing possibility that the US-China trade war enters Phase III in 2019, resulting in tariffs on all +$500bn of imports from China, similar to Goldman's conclusion. The bank notes that without more policy easing, this scenario implies weaker China growth, which directly impacts the commodity complex’s incipient recovery. And depending on the weight authorities give to monetary versus fiscal measures over the next 6 to 12 months, the renminbi could depreciate sufficiently to pull EM Asia and the non-oil commodity complex lower.
The other, and more interesting, concern is that US economic and equity market resilience - despite tariffs - will embolden the President on all geopolitical fronts – autos, NAFTA and particularly Iran – and thus risk a major miscalculation from sanctions that are tough to calibrate.
This possibility is the driver behind JPM’s revised oil price forecast for the next several quarters, from a previous average price forecasts for Brent of the low $60s (mid-$50s on WTI) in Q4 2018 and Q1 2019 to $85/bbl (WTI $76/bbl) over the next six months, with even a spike to $90/bbl increasingly likely. As a reminder, some analysts still believes sthat it was oil's superspike in the summer of 2008 that ultimately catalyzed the collapse of Lehman. Incidentally, the main driver of this upward price revision is the higher estimate of how much Iranian crude exports might decline due to multi-country respect for US sanctions that should come into effect on Nov 4th. While initially JPM had expected some 500kbpd to drop off the market, it now models a loss of 1.5mn barrels per day as more countries agree to comply with Trump's sanctions, and coming at a time when Saudi tolerance for oil prices above $80/bbl appears to be increasing.
Meanwhile, should Trump escalate trade war with China and impose 25% tariffs on all imports from China, it would take $8 off consensus 2019 EPS projections of $179 and reduce next year’s EPS growth from 10% to 5% year-on-year.
"Even with a forward multiple of 17, an EPS downgrade this large would end the US stock rally unless some other offset materialized."
In a similar analysis two weeks ago, Goldman predicted that a 10% tariff imposed by the US on all global imports would lead to a 25% drop in the S&P, to as low as 2,200, resulting in a bear market, and wiping out $6 trillion in market cap.
Trump's cockiness aside, going back to the latest market rally, JPMorgan also asks if it is the beginning of an unmissable strategic opportunity (lasting six months or more, delivering at least 10% upside) or just a more tactical one (lasting another week or two, delivering about 5% upside)?
In its response, JPM believes that on one hand a "strategically bullish view" is based on risk premia which are so high in assets like EM, the DAX, Autos, Base Metals and Metals & Mining stocks that they can absorb escalation, since by now most observers accept that this conflict will endure at least as long as Trump remains President.
The arithmetic behind this view could run like this: (1) the nominal sums affected by announced and threatened tariffs are trivial relative to the size of the US and Chinese economies, so don’t justify any more than a 0.25-0.5% cut in global growth through first round income effects; and (2) many cyclical assets have fallen so much this year that they discount a least a 1% slowdown in global growth from its current 3.5% pace. Even if catalysts are small, the value proposition seems huge.
Alternatively, a "strategically neutral but tactically positive view" runs like this:
- any estimates of first-round effects should be doubled or tripled given the immeasurable second-round effects around confidence, supply-chain disruption and tighter financial conditions, so apparently-cheap assets no longer look so compelling when adjusted for uncertainties;
- country-level improvements in key markets have been incremental rather than transformational;
- short covering could extend a few percent over the next week around the Sep 26th FOMC if the committee removes the word “accommodative” from its statement describing its monetary stance, thus suggesting that it might be near the end of its hiking cycle.
For what it's worth, JPM's increasingly cautious view - in light of Trump's unpredictability - is that when asked if the rally is "unmissably strategic", or "tactical", the conviction across the bank's various research teams, "is higher around the latter than the former." In other words, ride it out but be ready to bail.