The potential for a full blown trade war continued to weigh on the financial markets and the global economy during September. But, compared to the previous month, it was relatively quiet and uneventful in the lead-up to a fresh round of high-level trade talks in the US scheduled for the second week of October.
Investors remained sceptical about whether the two sides would be able to reach agreement and, as the meeting approached, it seemed less and less likely. In early October, China said it was prepared to negotiate a “partial” trade deal – a far cry from the 100% deal President Donald Trump is determined to achieve. The US wants a trade deal with China to include the protection of US intellectual property, removal of the requirement that US share their trade secrets with Chinese companies and for all tariffs to be eliminated.
In the week of the talks, it became increasingly apparent that it was not merely about achieving a trade deal but that there are many other issues at play. In another surprise move, the US blacklisted another eight Chinese technology firms for human rights violations and imposed visa bans on officials for oppressing Muslims in the Xinjiang region. The Chinese threatened to retaliate.
On the first day of talks, both parties indicated talks were progressing well. However, onlookers were still sceptical about whether these would result in a substantial and sustainable deal or whether they would just end with a short-term fix designed to quell market volatility and alleviate some of the trade-related downward pressure on the two economies. It appears that is exactly what has happened as the two countries on Friday have come to terms on a partial trade deal that would see the US delay tariff increases that were scheduled for next week.
Oil production disrupted by drone attack
Geopolitical tensions also ramped up in the Middle East during the month when a drone attack on Saudi Aramco’s oil facilities took out 5% of the world’s oil production. Houthi rebels took responsibility for the attack but Trump blamed Iran directly.
The oil price jumped 20% in the wake of the attack, with the North American Benchmark reaching $62. 90 before falling back $10 to about $53 on the news that the Saudis are confident will be able to achieve full production again by the end of November. The oil price was trading at about $55 before the attack.
The drone attack did highlight the security risks of Middle Eastern oil supplies and shone a light on Canada as a stable and secure source of fossil fuel. While refineries in eastern Canada are still importing crude oil, the attack does give political weight to the benefits and importance of building Canada’s pipeline capacity to get more Alberta oil to the market. To do so, however, projects like Keystone XL will have to surmount the legal, environmental and political challenges in the US.
Trump under impeachment pressure
In the US, Trump is juggling mounting pressure from US manufacturers and agricultural producers to improve the state of the economy, while doing damage control around his formal impeachment inquiry. He is accused of using the power of his office to solicit interference from a foreign country in the US 2020 election after allegedly urging Ukranian President Volodymyr Zelensky to investigate Presidential contender, Joe Biden
Brexit negotiations remain unresolved
Across the Atlantic, a messy and unresolved Brexit generated extreme uncertainty in the UK, with newly elected UK Prime Minister Boris Johnson trying everything in his power to make it happen, including shutting down Parliament. However, the Court ruled he had overstepped his powers and Johnson had to go back to the negotiating table with the European Union to attempt to come to a deal before the October 31 deadline. He is adamant that he will pursue a no-deal Brexit at the end of the month should agreement not be reached with the EU by then. Brexit has taken its toll on the UK business sector and the currency, with the pound trading at half of its value versus the dollar since Brexit was put on the table three years ago.
Fears of a global recession mount
At a global level, all the political and economic headwinds, including Middle Eastern geopolitical tensions and the intractable trade war, have substantially undermined global economic growth, with estimates for growth this year now one percentage point lower than previously predicted. US, the last bastion of developed market manufacturing growth, has also turned an ominous corner. The September IHS Markit Purchasing Managers’ Index, a much-watched economic leading indicator, entered contractionary territory for the first time in a decade. This provided concrete evidence of the worsening conditions that manufacturers in the US swing states have attributed to Trump’s trade policies.
The shock US PMI figure was said to have resulted from the uncertainty that is being engendered by the trade tensions, with falling export orders and growing inventories the main forces behind the deteriorating manufacturing conditions.
Elsewhere in the developed world, PMIs remained in contractionary territory and highly accommodative monetary policy has yet to turn these economies around. During September, outgoing European Central Bank President Mario Draghi announced a host of monetary policy easing measures, including reducing interest rates, introducing a tiered interest rate system to soften the impact of negative interest rates on banks and reintroducing quantitative easing.
The unintended consequences of negative rates
The jury is out on whether central bank accommodation is likely to have the desired effect and there is great concern about the unintended consequences of negative interest rates in the European area. Not only are negative rates putting relentless pressure on European banks’ ability to perform but they also provide market conditions that are conducive to zombie companies that are so indebted that they are unlikely to ever pay back their loans and add no value to the economy.
As another indication of the absurdities of negative interest rates, the Greek government recently managed to issue debt at negative yields little more than a year after emerging from a bailout program.
During September, the possibility of negative US and Canadian interest rates was raised. Trump has been putting great pressure on the US Federal Reserve to implement more aggressive rate cuts to get the economy going. So far the Fed has resisted this pressure but my view is that, with trouble brewing on the horizon, rates will remain at historically low levels for the time being. We cannot, however, predict with any certainty when that will change. Hence it is important to follow an investment strategy that is not purely rate dependent.
Another consequence of historically low interest rates in Canada is that the two largest cities, Toronto (second on the Global Real Estate Bubble Index) and Vancouver, are in bubble territory and showing signs of strain, according to the UBS Global Real Estate Bubble Index 2019.
After a more than 5% per year real increase in housing prices in Canada between 2000 and 2018, “the housing frenzy seems to be over for now,” says UBS. In Toronto, real prices almost tripled between 2000 and 2017 and in Vancouver real prices are 75% higher than they were a decade ago. “Over the last four quarters price growth has stalled and a correction set in. The introduction of taxes on foreign buyers, vacancy fees and stricter rent controls seem to have taken effect.” This doesn’t bode well for homeowners’ and consumer confidence, should these housing bubbles burst.
In China, while there have been some concerning economic numbers, the latest local and international PMI Indices came out above expectations, with domestic demand holding up the numbers. The Chinese Communist Party has been intentionally trying to shift from external sources of growth to internal, consumer-driven demand. However, one single positive number is by no means a trend and the Chinese economy has slowed materially in the face of the US’s increasingly protectionist bent and exports are showing strain.
Given the uncertainty shaping the global economy, there is no doubt a cloud of concern will continue to hang over what has been an historic period of economic expansion. Even if the economy does experience a recession, we have evaluated a number of companies that we would expect to maintain their value because demand is fairly inelastic for the products or services that they offer.
We are also looking at opportunities for investors in companies that may, in fact, experience growth during an economic slowdown. As always, we remain focused on finding opportunities in quality companies in order to grow our clients’ wealth.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at firstname.lastname@example.org