Before digging into what a U.S.-China trade deal needs to look like and how to position your portfolio depending on various outcomes, we need to examine a few characteristics of the market and the economy.
The recent strength in equities has more to do with the Fed shifting from hawkish to dovish than with trade deal progress (the 10-year Treasury yield is barely changed on the month, which confirms the source of the strength for me).
Tariffs and uncertainty around trade have played a large role in recent weakness in global economic data. There are many factors, but trade is one of the biggest. Tariffs are taking their toll as companies have few easy workarounds left and trade uncertainty is stalling projects.
From a market positioning standpoint, I think investors have been more cautious in terms of allocations than we typically see during such a strong run-up in stocks. I also strongly believe that most investors plan to "sell the news" of the trade deal, which could be the ultimate opportunity.
That is my view of the current market and economic setup as we near the trade deadlines. And my view has only been reinforced by President Trump's announcement that the latest China tariffs scheduled for March 1 will be delayed based on "substantial progress" in the talks.
Anatomy of a Trade Deal
We need to see some combination of the following to consider it a trade deal:
- Reasonably detailed outline. We don't need to have an actual deal signed, but we need more than a photo op. We need to see actual details outlined and a path to implementation.
- Lower tariffs than where we started 2018. Just rolling back new tariffs is not enough. We need to see reductions to tariffs that have been outstanding for years, if not decades.
- China agreeing to buy LNG. China will buy agricultural goods and that is helpful, but the real upside is buying LNG (liquified natural gas). That will require further infrastructure spending in the U.S. to be able to produce and deliver enough LNG (assuming the targets from China are large).
- Better Access. Ending the policy where China requires 51% ownership to access their markets or where they impose stringent production requirements to do business in China is also important. It allows companies to behave as companies and create the proper supply chains they want and to manage themselves effectively. I think we need to see moderate progress on this. Mere lip service is not enough, but complete freedom isn't necessary either.
- A mechanism for protecting intellectual property rights. I have very low expectations on this one. Finding a way to create enforceable protection that is both meaningful and timely seems difficult to achieve at best. The market seems to have difficulty focusing on risks with very long-term horizons, which is why I think that weak intellectual property protection won't slow markets down.
The Game Plan for Trading the Trade Deal
Keeping current positioning and sentiment in mind, there is likely to be some initial downward pressure on the markets regardless of the outcome as the desire to "sell the news" is so high. Having said that, I think continuing to be long risk makes sense and we will adjust positioning as the events play out.
- Talks break down. Sell stocks and credit hand over fist. The S&P 500 is heading back to 2,400.
- A deal as described in the 'Anatomy of a Trade Deal' section above is concluded. Expect a near-term pop, which may not even last a full day, followed by selling pressure. I would wait to be fully invested until the 'sell the news' has occurred.
- Immediate end to tariffs implemented in 2018. If both sides roll back recently added tariffs in conjunction with the trade deal announcement it is time to invest more. This will signal the sincerity of the deal and should do a lot to reduce the "sell the news" effect.
- Ending steel tariffs with Mexico and Canada. Buy, Buy, Buy! This is outside the scope of the deal with China but would be a clear sign that the administration has changed its views on trade. This could usher in a new era of reduced tariffs and barriers to trade across the globe. The market should take this as a strong signal, and I could easily see the S&P 500 getting to 3,000. (This would only occur if they roll back the 2018 tariffs as above.)
- We turn around and increase rhetoric on auto tariffs with Europe and Japan. Sell, Sell, Sell! Trading one trade war for another won't help. And while the saying "As GM Goes, So Goes the Nation" might not be as true as it once was, anything that hurts autos hurts the economy. Would the S&P 500 go back to 2,400 on this? I'm not sure, but if it is viewed as a clear signal that we won't follow through with China, then 2,400 might be optimistic.
This game plan doesn't mean we can completely ignore the other issues that we've discussed, but I think trade will be the biggest driver. All of these events will play out in the coming weeks, making it critical that we know what to look for in advance and how to react when we see evidence of those events occurring or not occurring.
I remain optimistic and think we will be surprised to the upside, but I will not hesitate to turn to risk-off mode if we don't get what I'm looking for.
Peter Tchir is a regular contributor to Real Money. Click here to get columns like this each day from Jim Cramer, Stephen "Sarge" Guilfoyle, Helene Meisler and Jim "Rev Shark" DePorre.
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