Author: Kristina Hooper (Chief Global Market Strategist)
Two developments last week suggest that we have entered a period of improved economic policy certainty. Both the UK election and the US-China Phase 1 trade deal promise to bring far more clarity for businesses as they plan for 2020 and beyond. If so, this could be a welcome gift for the economy and the stock market as we enter the holiday season.
A Jan. 31 Brexit looks likely
Thanks to a Conservative Party landslide in the Dec. 12 UK Parliamentary election, we expect Brexit can be completed by the end of January, but trade negotiations on the future relationship of the UK and the European Union may be stretched out beyond December 2020. At this point, it looks possible that the UK may exit the EU’s single market (which allows for the free movement of goods and services among the different countries in the EU), but remain in or align with the customs union (which establishes a common system of tariffs and import quotas for trading with non-members).
As the details solidify, I would expect to see a gradual and sustained recovery in investment and a reversion to a higher growth rate that is somewhere between that of the eurozone and that of the US (even if it is slower than pre-Brexit economic growth). If so, sterling is likely to consolidate some further gains, but still at a discount to pre-Brexit levels. Gilt yields could move somewhat higher still. Equities are likely to rise significantly. With uncertainty easing, the Bank of England might even attempt to catch up to the global easing frenzy with a rate cut.
A Phase 1 trade deal could provide significant benefits
The day after the UK election, it was announced that the US and China have agreed on the first phase of a trade deal — a development that I believe should be very positive for a number of industries.
This Phase 1 deal includes several items that could benefit US industries:
Going forward, the rollback of additional existing tariffs over time is expected as well — although this is far from certain. If these rollbacks were to occur, one likely beneficiary is the auto industry (US and German auto companies).
Overall, the Phase 1 deal should be positive for business investment because it reduces economic policy uncertainty, and increased business investment should benefit the global economy. I expect this to create an upward bias for stocks globally — especially for Chinese equities, which in my view have been unfairly beaten down in the last several years.
Neither development is a ‘done deal’
While increased certainty around Brexit and a Phase 1 US-China trade deal are both very positive developments, nothing is a “done deal.”
In conclusion, last week’s developments are very positive. However, until Brexit is completed and a Phase 1 trade deal is signed, there is the potential that uncertainty could spike again. In our view, this means that while maintaining a diversified portfolio with adequate exposure to risk assets is important, it’s also critical to plan for the potential for higher volatility in the short term.
Happy holidays
In celebration of the holiday season, Weekly Market Compass will not publish for the last two weeks of the year. We’ll be back on Jan. 6. Happy Holidays to you and yours!