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Markets Show U.S. Gaining Upper Hand Over China in Trade War

Elena Popina

(Bloomberg) -- The U.S. is starting to overtake China in the trade war, at least in financial markets.

Treasuries have held on to this year’s rally, the dollar remains strong despite three interest-rate cuts and U.S. stocks have been notching a string of records.

Meanwhile, Chinese shares, the yuan and the country’s government bonds have recently struggled to find momentum. An equities sell-off accelerated on Friday, when a sudden tumble in Hong Kong stocks spilled over to the mainland market, where investors took profits in crowd favorites like Kweichow Moutai Co.

The outperformance has been especially notable in the past months, with the S&P 500 Index trading at its priciest multiple ever relative to the Shanghai Composite Index.

It highlights the diverging forces driving sentiment in the countries’ financial markets: the Federal Reserve’s dovish tilt the past year has supported risk sentiment in the U.S., whose economy has held up better than anticipated. In China, the central bank has stuck to its prudent approach to stimulus despite a string of disappointing economic data. The fallout has included increased financial stress and economic growth expanding at the slowest pace since at least the early 1990s.

“The U.S. stock market has been really strong, while momentum in Chinese stocks seen at the beginning of the year has kind of waned,” said Gerry Alfonso, executive director of the international business department at Shenwan Hongyuan Group Co. “China’s slowdown has impacted investor sentiment even more than developments on the trade front.”

In August, the U.S. and Chinese stock benchmarks were the most highly correlated in four years. But that relationship evaporated, with the S&P 500 climbing 7.2% since June 30 while the Shanghai Composite has lost 3.6%.

“Global investors see a trade war leading to greater risk for investment in China,” and emerging markets than the U.S., said Hyde Chen, an equity analyst with UBS Wealth Management in Hong Kong. “U.S. stocks fared better because Asia’s economy as a whole suffers more from trade impact.”

Investors have been demanding the most compensation to hold Chinese sovereign bonds relative to U.S. Treasuries in two years. The spread between the countries’ 10-year bond yields widened to 1.6 percentage points in October, as liquidity concerns kept China’s bonds from joining in on a global debt rally. In late 2018, the yield gap shrank to its smallest since 2010, just 25 basis points.

The currency of a country easing monetary policy often weakens. But the ICE U.S. Dollar Index has risen more than 2% this year while the yuan has struggled, in August weakening beyond 7 per dollar for the first time since 2008. That weakness prompted the U.S. to label Beijing a currency manipulator.

Falling transaction volume shows yuan traders are preferring to stay on the sidelines for now, as a U.S. bill supporting Hong Kong protesters threatens to get in the way of a phase one trade deal.

The Shanghai Composite Index is up 15% for the year following its drop on Friday, versus a peak of 31% in April. That’s a relatively solid performance considering the headwinds facing China’s economy, according to analysts at both Goldman Sachs Group Inc. and Morgan Stanley.

Both brokerages this month cut their view on A-shares to neutral from overweight after this year’s advance, saying foreign inflows may slow following this year’s heavy purchases. Meanwhile, sub-6% economic growth in China -- which Goldman Sachs is predicting for 2020 -- may provoke “concerns among market participants.”

(Updates market activity in third, seventh and 12th paragraphs)

--With assistance from Cindy Wang.

To contact the reporter on this story: Elena Popina in Hong Kong at epopina@bloomberg.net

To contact the editors responsible for this story: Sofia Horta e Costa at shortaecosta@bloomberg.net, Kevin Kingsbury

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