Phase One deal out of the way allowing stocks to advance further
Global stock markets rallied as Phase One of the US/China trade deal was finally struck with US agreeing to cut in half the 15% import tariffs on $120bn of Chinese goods while cancelling the planned additional duties on $160bn of imports which was due to come into effect on December 15th. Although the US retained its 25% levy on $250bn of other Chinese imports, Phase Two of the trade deal is said to allow these tariffs to be lowered also. In return, China has pledged total purchases of US goods worth $200bn, including $40-$50bn in agricultural goods while lowering tariffs on certain US goods. Beijing also promised to tighten its intellectual property laws, allow more access to its financial markets, keep its currency stable and ban forced transfer of technologies.
The deal came even sooner than what we had hoped, before the year-end, and doing away with any fanfare that would require leaders of both sides to meet face-to-face. Mr Trump also complied with China’s request for mutual respect by simply declaring that they both needed this deal, refraining from any derogatory comments that could have made the optics leave China look desperate or weak. The deal is scheduled for a signing ceremony in January once the full text of phase one is agreed to by lawyers from both sides.
Phase Two agreement to be much narrower in its scope
Whatever Phase Two of the trade agreement might entail, it promises to be much narrower in its scope as it is difficult to see any easy hurdles remaining. As we mentioned last week, we think much now rides on the US president vetoing the recent passage of the US House bill which condemned China’s crackdown on its Uigher population to allow further progress on trade as we enter phase two. As we explained, China has proven to be far more sensitive to any interference regarding its domestic mainland policies than to the HK democracy bill which was signed into law given that at least on paper, China itself does endorse the ‘One China Two Systems’ rule in HK.
We also think any US demands related to China changing course in regards to its industrial policies are simply out of the question as that would require a fundamental change in its political system. Indeed, if anything we are seeing concrete signs that Chinese state enterprises are accelerating spending plans in areas like semiconductors and other technology components to reduce dependance on the American supply chain. Interestingly, prospects of lifting the US ban on buying Huawei’s telecommunication equipment or supplying it with components was absent in Phase One agreement as China must have understood that as a recognised national security threat, Trump’s hands were tied to barter on Huawei.
Japan stock market the biggest beneficiary of improving trade
However, a Phase Two trade deal is more next year’s concern, possibly becoming more relevant in the April-June quarter. With the size of Japan’s trade with China being 80% bigger than that with the US, at this stage we think Japan’s highly cyclical stock market is one of the biggest beneficiary of any detente in this trade conflict and has much more room to rally.
With the yen weakening towards the psychological 110 level against the dollar, the 10 year JGB yield now touching zero and looking to head higher, helping Japan’s financial industry and the planned fiscal stimulus coming into effect, all at the same time, we don’t see much headwinds that will keep our market depressed. Indeed, we believe we are very much on course to hit our year-end target for Topix north of Y1900 level, heading close to its January 2018 highs. With valuations looking highly attractive, Corporate Japan buying back shares, improving its governance structure and restructuring more aggressively than at anytime we have seen it in the past 30 years, we go into 2020 with the view that our stock market will be one of the best performing markets globally.