Investors and traders celebrated on Monday the news that Presidents Trump and Xi had brokered over the weekend a ceasefire in the trade war between China and the United States. Judging from public comments, most economists seemed less excited, arguing little had changed. There is important information content in understanding why they differ, and what this implies going forward for the economy and markets.
For investors, the weekend deal was a “goldilocks” outcome: good enough to stop a further escalation in the tariffs’ tit-for-tat that hampers trade and slows global growth; but not too good to dissuade the Federal Reserve from cutting interest rates. As such, investors feel comfortable putting more of their money at risk in surfing what has been a remunerative multi-year liquidity trade.
Economists focus on the fact that the ceasefire doesn’t durably lift the trade policy cloud that has been hanging over the global economy. As such, it won’t encourage companies to invest more. At the same time, since the cost of borrowing is already low and hardly a hinderance for the bulk of corporate America, a Fed rate cut is unlikely to move the needle on growth and investment spending. And their relative pessimism about global economic prospects was reinforced by today’s poor data on manufacturing activity in China and Europe.
Together, the two views highlight a phenomenon that has been going on for a while, courtesy of central banks: that is, the decoupling of elevated asset prices from more sluggish corporate and economic fundamentals.
Together, they also point to major questions facing both policymaking and markets: How will the decoupling be resolved ultimately. Will improved fundamentals validate high asset prices and push them along further; or will the gravity of sluggish fundamentals prevail and pull asset prices down? And when will the convergence occur?
For now, investors and traders are comfortable in continuing to bet on the beneficial market impact of liquidity, thus putting aside concerns about fundamentals; and central banks seem committed to inject more liquidity into the system even though the transmission mechanism to real economic liquidity (as opposed to asset prices) is weak. While careful not to opine on timing, and rightly so, most economists question the likelihood of sluggish fundamentals validating the elevated asset prices. And all hope that liquidity will buy enough time for politicians (especially in Europe) to get their act together on pro-growth policies.
Where you should end up depends in large part on your time horizon.
If you are investing for the short-term, continuing to benefit from the liquidity wave seems attractive. If you have a considerably-longer time horizon, however, this may be a good time to take advantage of the strong year-to-date performance to trade up in quality, be more selective in where and how you invest, and build a larger reserve cushion to take advantage of possible dislocations.
And, whatever your time horizon, it’s not a good idea to fade relative portfolio positioning favoring the US assets versus those in the rest of the world (where economic and financial prospects are a lot trickier).
Mohamed A. El-Erian is the chief economic advisor to Allianz, the corporate parent of PIMCO where he served as CEO and co-CIO (2007-2014). A Bloomberg columnist and Financial Times contributing editor, he was Chair of President Obama’s Global Development Council and has authored two New York Times Best Sellers: the 2008 “When Markets Collide” and 2016 “The Only Game in Town.”