‘The art of the deal’: Why this veteran strategist isn’t concerned by the trade war headlines

Ride the wave. Octavio Passos/Getty Images.
  • Stock market volatility has increased noticeably in 2018.
  • Trade tensions between the US and China, along with higher short and longer-dated borrowing costs, are two factors that have contributed to the recent selloff.
  • Shane Oliver, head of investment strategy and chief economist at AMP Capital, believes now’s not the time for investors to panic.

After a prolonged period without a significant market pullback, unprecedented in some instances, investors have been provided a brutal and abrupt reminder over the past couple of months that stocks can and do fall.

While there’s the odd exception, many major markets have suffered some steep falls, snapping what appeared to be a relentless march higher.

From late January, US and European markets have shed 10%, with Chinese and Japanese stocks faring even worse with losses of 12% and 15% respectively.

Even in Australia, despite a weaker Australian dollar, stocks haven’t been immune, with the benchmark ASX 200 currently down more than 5%.

The combination of higher short and long-term borrowing costs, trade tensions between China and the United States, along with the increased prevalence of low-volatility investment strategies that acted to amplify market volatility at the start of February, have all acted to derail the bull market in stocks.

The question now is whether this is just a setback before even higher highs or the start of something more sinister?

While few will disagree that stock market volatility is unlikely to return to the lows seen last year, Shane Oliver, head of investment strategy and chief economist at AMP Capital, believes now’s not the time to panic.

Drawing upon his decades of experience, he says that despite the unnerving headlines and recent market selloff, periodic setbacks in share markets are both healthy and normal and not to be feared by longer-term investors.

In particular, Oliver says recent trade frictions between the United States and China should be seen as the start of a negotiation period rather than the start of a full-fledged trade war that could derail the global economy.

“President Trump is aiming for negotiation with China,” Oliver says, noting that the US tariffs on China are just a proposal rather than in place.

“Trump’s aim is negotiation with China and things are heading in this direction.

“Consistent with [Trump’s book] ‘The Art of the Deal’, he is going hard up front with the aim of extracting something acceptable.”

And Oliver says Trump will likely get a deal, noting that “a negotiated solution with China looks the more likely outcome”.

“It looks scary and is generating a lot of noise, but an all-out trade war will likely be avoided,” he says.

Nor is Oliver particularly concerned about a recent spike in short-dated borrowing costs in money markets, taking the view that the recent widening in the spread between overnight and three-month inter-bank borrowing costs is not a sign of increased credit stress as was the case before the global financial crisis.

Source: AMP Capital

“So far the rise in the US Libor/OIS spread is trivial compared to what happened in the GFC and it does not reflect credit stresses,” Oliver says.

“Rather the drivers have been increased US Treasury borrowing following the lifting of the debt ceiling early this year, US companies repatriating funds to the US in response to tax reform and money market participants trying to protect against a faster Fed.

“So, it’s not a GFC re-run and funding costs should settle back down.”

As for the threat posed by more interest rate hikes from the US Federal Reserve, Oliver says that even if it hikes rates another three times this year — a view he and an increasing number of market commentators now expect — it would still leave policy a long way from being tight and a potential risk to US economic growth.

“We continue to see the Fed raising rates four times this year and this will cause periodic scares in financial markets,” he says. “The Fed looks to be tolerant of a small overshoot of the 2% inflation target on the upside and the process is likely to remain gradual.”

While Oliver says the risks posed by monetary policy will increase as the Fed moves towards the end of its tightening cycle, he says we’re still not at that point yet.

And given still-easy global monetary policy settings, and an expectation that stronger economic conditions will help lift global earnings growth by around 14% this year, Oliver has some simple advice to investors who are becoming nervous about the recent spate of negative headlines: cut out the noise.

“In periods of market turmoil, the flow of negative news reaches fever pitch which makes it very hard to stick to your well-considered long-term strategy let alone see the opportunities,” he says.

“Shares often bottom at the point of maximum bearishness. And investor confidence does appear to be getting very negative which is a good sign from a contrarian perspective.”