Bullish and Bearish View of What G-20 Summit Means for Stocks

To hold a view on asset prices in 2019 is to hold a view on trade. No issue can claim a greater market influence, and few are more divisive.

To mark a seminal event in the saga, this weekend’s Group of 20 summit in Osaka, Japan, Bloomberg asked writers from its Markets Live blog -- Singapore-based Mark Cudmore and Andrew Cinko in Princeton, New Jersey -- to state opposing views on the outcome.

Bear Case - Cudmore

Unless the U.S. and China reach a grand bargain that sees global trade blossom again, it will be apparent in less than a year that this was the weekend that foretold the bull market’s doom. A truce that maintains the current level of tariffs will likely be insufficient to turn the rapidly deteriorating economic outlook. And don’t count on the Fed to save the day either.

In three days we are likely to see the JPMorgan global manufacturing PMI slide further into contraction territory, according to last week’s preliminary PMI readings. It has fallen for 13 months.

It’s a full-blown global theme: Data on trade and manufacturing continue to shock. The Bloomberg Economic Surprise index for the U.S. has been negative all year. The equivalent for the euro area has been negative for nine months.

And, yet, economists haven’t changed their forecasts for global growth since the trade war escalated in May. Work that one out: The data pre-tariffs consistently came in below expectations, and then the world’s two largest economies imposed a bunch of tariffs. And yet the consensus expectation for 2019 world GDP growth is unmoved since April.

What gives? Some would say that economists are in denial and hoping the trade war is all a bad dream. It may be fairer to acknowledge the difficulties of their profession. They don’t want to slash economic forecasts ahead of the G20, only to be compelled to upgrade them again in July if the U.S. and China achieve a deal.

That’s why this bearish economic prognosis may soon turn into a markets one. While there’s optimism that this weekend’s Trump-Xi meeting will provide the breakthrough, evidence doesn’t support the perspective. A narrative among U.S. investors is that some trade deal will eventually be reached, because Trump will want one to boost the stock market into election year. The problem with that is it overlooks that there are two parties to the negotiation and it’s the 'other' side that may provide the larger roadblock.

Since May, the communication on mainland China has shifted immeasurably. Previously, any tensions with the U.S. were played down. The picture is vastly different today. After talks broke down in May, the tense situation with the U.S. has almost been hyped up domestically, with frequent mainland media references to imperial aggression and a new Long March. There have been references to the mistakes of the treaties of the Opium War era -- signed between 1842 and 1860. There’s little reason to doubt the sincerity of China when it states that a trade deal can only be established when negotiated on equal terms. Such a scenario appears unlikely, which explains why China is preparing for sustained tensions via aggressive and targeted stimulus for its domestic economy.

So, unless one believes that Trump will suddenly surrender his fight and abandon almost all demands on China, a trade deal seems very unlikely. At best, this weekend may bring a handshake, some statements of mutual respect and an expressed desire to reach a deal. In subsequent weeks, a gloomier reality will become apparent.

And if you’re counting on the Fed to save stocks, you may want to check how well that strategy has worked in the past: It hasn’t. This century has provided two recessions -- both coinciding with periods when the S&P 500 gave up half its value. In September 2007, the Fed cut rates by 50 basis points and by another 25 in October; it didn’t prevent a U.S. recession in December. Likewise, the easing cycle that began in January 2001 didn’t stop the recession beginning in March 2001. And to make that point more worrying, the Fed was able to cut rates by at least 500 basis points each time to fight the downturn. With the benchmark rate at 2.5% today, it doesn’t have the luxury.

So, as we approach the G-20 and its supposed status as the last potential savior, the words of Dante Alighieri should ring loudly in your ears: 'Abandon Hope All Ye Who Enter Here.'

Bull Case - Cinko

For the less-apocalyptically minded, optimism boils down to one question: even without a grand bargain, where is the proof that the world economy is going over the edge into a recession?

The war of words over trade may have gone from genteel to acerbic, but it has done so over the course of many months, giving everyone time to assess the many paths it may take and the potential costs involved. Has it affected manufacturing? Certainly. But not so much as to spur a swan dive. Output gently tumbling and even PMIs below 50 aren’t overly alarming. Is 2008 so long ago that we’ve forgotten the 20-point plunge in China’s PMI over the course of just seven months? No such Armageddon is currently seen in the data.

And what of the hit to the economy? A 25% tariff on all Chinese goods imports amounts to “an additional tax on U.S. businesses/consumers of about $100 billion over year-ago levels (assuming no currency offset or substitution),” writes RBC economist Tom Porcelli in a note June 24. A 0.5% hit to the U.S. economy isn’t a rounding error, but it’s not a recession.

Bears will say, it’s not the money, it’s the hit to consumer confidence caused when politicians can’t agree. It’s the wider hit to global stability. Those are points bulls and bears can agree on, but where we differ is in the damage done. Already there are numerous reports of supply chains moving to Thailand, Taiwan or Vietnam. Not to mention legal workarounds that will keep the cross-ocean shipments going.

And corporate management teams, while not happy, have had the luxury of time to work up a plan of action should the tariffs become reality. Will that spell doom and gloom for corporate earnings? Highly doubtful given human ingenuity. A savings glut in the U.S. is hitting new highs. That’s money that can be used to absorb shocks and offset the cost of the tariffs.

As for the Fed, past instances of futility aren’t relevant. Fine, its monetary levers are never enough once a recession is underway. But it’s far from clear the Fed is already behind the curve. A possible July move is correctly thought of as an “insurance” cut, to preempt panic. Data this week show the U.S. hasn’t hit a brick wall, but is merely getting rough around the edges. An interest-rate course adjustment, a la the mid-1990’s, may be all that’s needed to keep growth alive.

Outside of the FOMC, the markets have already given a big boost to animal spirits. Financial conditions remain easy, unlike the dark days of December. Or for that matter 2015 and 2016.

The old saying is that when the U.S. sneezes, the world catches a cold. It’s a good thing for the world that America has economic momentum, fat bank accounts and a resilient Fed -- no matter what comes out of Osaka this weekend.