By Erik Knutzen, Chief Investment Officer - Multi-Asset Class
Our geopolitical risk focus turns to Europe - and trade conflict with the U.S. looms largest.
When I talk with clients I get asked a lot about the key political or geopolitical risks that asset allocators should look out for. My answer is that most of what gets into the headlines is interesting but irrelevant - it won't affect an economy's growth outlook or change the prospect for inflation.
Occasionally a geopolitical issue rises to the level of a true threat to markets. For much of 2018, the main example was the worsening trade dispute between the U.S. and China, particularly as it coincided with a slowdown in China's economy.
That trade conflict appears to be diminishing. However, our more recent concern has been the potential for Europe and the big, globally integrated auto sector to become the next target of the U.S. presidential administration's trade priorities. Last week, that concern regarding a brewing Atlantic storm escalated. We think the locus of geopolitical risk has shifted decisively to Europe, and in doing so it has brought the auto industry into play.
As detailed in our latest Asset Allocation Committee Outlook, we are growing more confident that the newly dovish stance of the major central banks, along with signs of economic stabilization in China, will lead to a soft landing in the U.S. and a growth recovery in the rest of the world.
Two weeks ago, strong Purchasing Managers' Index (PMI) data out of China set off the latest rally in risk assets. Friday's trade and vehicle sales data indicate that domestic demand remains tepid, but Citigroup's Economic Surprise Index for China is now one of the few with a positive reading, and when the International Monetary Fund published its new 2019 GDP growth forecasts last Tuesday, China was one of the only major economies to get an upgrade, to 6.3%. At the same time, U.S. officials were sounding upbeat on prospects for a mutually satisfactory deal on trade and intellectual property.
It was the emergence of new political risk out of Europe that put the brakes on the market rally last week - but this time it had nothing to do with the usual suspects of Brexit, Italy, a populist election surge, the succession plans for Mario Draghi or Angela Merkel, separatists in Spain or yellow vests in France.
Instead, it was the return, with added teeth, of a 15-year-old complaint by the U.S. about European subsidies for Airbus (OTCPK:EADSF) (OTCPK:EADSY). Citing the World Trade Organization's finding that they have had "adverse effects on the United States," the U.S. threatened tariffs on $11 billion worth of European imports should the subsidies continue.
This is not such a big deal unless you trade in cheese, wine or ski suits. However, the European Union made it a bigger deal with talk of retaliatory tariffs. And it could turn out to be a very big deal should anything in the U.S. Commerce Department's "Section 232" report on auto imports, delivered to the White House back in February but not yet published, suggest that European car parts pose a security risk.
That would open the door to tariffs and, as Brad Tank wrote on these pages last July, the economic impact of a 25% tariff on European autos and auto parts would be clear, immediate and global. It could yield 8% total sector cost inflation and feed into a demand shock that could take as much as half a percentage point off of global GDP growth.
Even the messiest of Brexits would struggle to be that damaging.
Do we expect this storm to break?
No, we do not. The Asset Allocation Committee maintains a cautious overweight view on European markets. We think the improvement we see in China will eventually spur growth in other global trading economies such as Germany and Italy. EU ministers are likely to give the European Commission the go-ahead to open trade talks with the U.S. today, which could help to cool the rhetoric.
Nonetheless, we have also been warning clients about risk and volatility. When they ask which political risks they should prioritize - alongside the market risks of a weak first-quarter earnings season, further disappointing data releases out of China or elsewhere, and general late-cycle nervousness - this pivot of the U.S. administration's trade dispute from China to autos - heavy Europe would now be at the top of the list.
In Case You Missed It
- U.S. Consumer Price Index: +0.4% in March month-over-month and +1.9% year-over-year (core CPI increased 0.1% month-over-month and 2.0% year-over-year)
- European Central Bank Policy Meeting: The Governing Council made no changes to its policy stance
- China Consumer Price Index: +2.3% year-over-year in March
- U.S. Producer Price Index: +0.6% in March month-over-month and +2.2% year-over-year
What to Watch For
- Tuesday, 4/16:
- NAHB Housing Market Index
- China 1Q 2019 GDP
- Wednesday, 4/17:
- Japan Purchasing Managers' Index
- Thursday, 4/18:
- U.S. Retail Sales
- Japan Consumer Price Index
- Eurozone Purchasing Managers' Index
- Friday, 4/19:
- U.S. Building Starts and Housing Permits
- Andrew White, Investment Strategy Group
Statistics on the Current State of the Market - as of April 12, 2019
|S&P 500 Index||0.6%||2.7%||16.7%|
|Russell 1000 Index||0.6%||2.7%||17.1%|
|Russell 1000 Growth Index||0.6%||3.0%||19.5%|
|Russell 1000 Value Index||0.6%||2.5%||14.7%|
|Russell 2000 Index||0.2%||3.0%||18.0%|
|MSCI World Index||0.5%||2.6%||15.5%|
|MSCI EAFE Index||0.3%||2.3%||12.7%|
|MSCI Emerging Markets Index||0.4%||3.0%||13.2%|
|STOXX Europe 600||0.7%||3.2%||14.6%|
|FTSE 100 Index||0.0%||2.4%||12.1%|
|CSI 300 Index||-1.8%||3.0%||32.6%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||-0.1%||0.8%|
|Citigroup 10-Year Treasury Index||-0.5%||-1.2%||1.9%|
|Bloomberg Barclays Municipal Bond Index||0.1%||-0.2%||2.7%|
|Bloomberg Barclays US Aggregate Bond Index||-0.1%||-0.4%||2.5%|
|Bloomberg Barclays Global Aggregate Index||0.2%||-0.3%||1.9%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.4%||1.4%||6.6%|
|ICE BofA Merrill Lynch U.S. High Yield Index||0.6%||1.1%||8.6%|
|ICE BofA Merrill Lynch Global High Yield Index||0.6%||1.1%||7.7%|
|JP Morgan EMBI Global Diversified Index||-0.3%||-0.1%||6.9%|
|JP Morgan GBI-EM Global Diversified Index||0.5%||1.7%||4.7%|
|U.S. Dollar per British Pounds||0.7%||0.5%||2.9%|
|U.S. Dollar per Euro||0.8%||0.8%||-1.0%|
|U.S. Dollar per Japanese Yen||-0.2%||-1.1%||-2.0%|
|Real & Alternative Assets|
|Alerian MLP Index||0.1%||1.4%||18.5%|
|FTSE EPRA/NAREIT North America Index||0.2%||1.1%||17.3%|
|FTSE EPRA/NAREIT Global Index||0.1%||0.4%||15.5%|
|Bloomberg Commodity Index||0.5%||2.1%||8.6%|
|Gold (NYM $/ozt) Continuous Future||0.0%||-0.3%||1.1%|
|Crude Oil (NYM $/bbl) Continuous Future||1.3%||6.2%||40.7%|
Source: FactSet, Neuberger Berman.
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