The US-China trade war has the potential to become a new cold war as both sides jostle for global dominance, according to Pictet Asset Management’s multi-asset head Andrew Cole (pictured), who said that it is likely to be one of the dominant issues in the second half and beyond. While markets were preoccupied by a potential rate cut by the Federal Reserve during the first half of the year, the prospect of escalation in a US-China trade war is likely to be one of the key issues for the latter half.
“The market is always a pretty simple beast, in that the market really can only ever think about two or three things at any moment in time,” said Pictet’s Cole. “And it tends to be the two or three things that are under its nose.”
The US-China trade war is a familiar concern among multi-asset managers, with Salman Baig at Swiss asset manager Unigestion also highlighting the issue. However, Pictet’s Cole warned that it is an issue that is unlikely to go away any time soon.
Performance of indices in Us dollar YTD
Source: FE Analytics
“I don’t think we’ve been surprised by the weakness in economic momentum globally,” he said. “We haven’t expected – and to some extent don’t expect – any resolution to the US-China trade dispute and our working hypotheses is that that is going to be a persistent feature.
“I think it’s probably going to be with us for a decade. I think that this is the new ‘cold war’. The US is redefining and resetting how it engages with China.”
What this means, Cole said, is that both China and the US will have to develop their own trade agendas.
“I think, when it comes to it, China will develop its own little trade thing and the US will develop its own trade set up,” he explained.
“This means if you’re going to build a 5G network presumably one part of the world will say ‘Well we’re happy to go along with China and we’ll have Huawei’ and another part of the world will say ‘No, we’re not going to have Huawei, we’re going have to build our own’. You’ll get two of everything.
“I think it’s going to be very focused where the big tensions are and around what the US and the West can legitimately argue is about security and 5G is one of those things.”
The significance of this goes beyond markets and reflects a break and shift in the West and China’s relationship spilling over into politics, the two now being more linked than ever.
As Cole pointed out, trade has been the way that the US has engaged with the rest of the world, and arguably helped maintain its global leadership status.
This has helped economies become richer and bring about the rise of a middle class and, consequently, democracy thus keeping non-capitalist regimes at bay with the exception of China.
What this means for Europe, and the UK – in particular, given Brexit – will be another layer of decision-making and uncertainty in Cole’s outlook.
“Interestingly, Europe sits in the middle and probably loses out to both because it isn’t very good at deciding whose side do they want to be on,” he said.
Push the UK and it will know which way to jump, Cole(pictured) added, but for the EU bloc it will be a much more problematic situation.
The consequences of a trade war are likely to “throw some grit into the oil of free trade supply chains”, according to Cole.
“For the corporate sector I think that’s a threat to profit margins, more the persistent increase in profit margins,” he added. “Whilst the market today continues to predict that you’ll never see an ounce of inflation ever again, it might be that this trade disruption – certainly should it continue to escalate –is a supply shock that creates some inflation at some point.”
Translating this onto his own portfolios the Pictet multi-asset head said that what you cannot do is to sit back and wait for a resolution.
“We look for the headlines to come out of these meetings where everyone goes ‘Hooray there’s a deal’ which can actually turn around the global economy and get back on track,” he said.
As such, multi-asset managers have a lot more freedom to position for different outcomes, but Cole remains as cautious as he was at the start of 2019.
“We’d like to get confirmation that our leading economic indicators are indeed troughing and at that point you will get modest outperformance of equities over bonds.” he said. “And it means you’ve got to run a riskier portfolio, but you’re being paid to do that and frankly clients want to make money and not lose money – which is what bonds are almost guaranteed to do.”
Another aspect of his positioning has been “volatility insurance” the Pictet multi-asset head said while the economic and political world itself has become more uncertain it has not been a highly volatile one.
“What I mean by that is that the price of volatility, the price of portfolio insurance, has very rarely lulled,” he said. “So how do we use that to our advantage?
“We have some nervousness about equities in the near term and we don’t have a lot of exposure but actually it’s very cheap to own the upside.”
Indeed, Cole said there is “cheap optionality” for them to improve their risk protection on the portfolio at a time where the increased correlation between traditional assets such as bonds and equities means they provide less diversification.
Meanwhile, the ‘noise’ surrounding geopolitical events and the impact on global markets has been unavoidable even for bottom-up investors.
“The markets seem to think that interest rates can go down forever at the moment, when a year ago they were going up forever,” said Cole.
However, the unrecognised risk is if economic data stops getting worse. Then interest rate expectations are going to change and people will think that a recession is likely within the next 12-18 months rather than four or five years.
“It’s a bit of an outlier view today but do I think we’ll get the economic data that helps support that view,” he said.
Performance of fund vs sector since launch
Source: FE Analytics
Cole co-manages the £253m FP Pictet Multi Asset Portfolio fund along with Shaniel Ramjee. It is a multi-asset absolute return fund that targets positive return in excess of the ICE Libor GBP three-month rate plus 4 per cent over rolling 12-month periods.
Since launch in June 2015, the fund has made a 13.65 per cent total return compared with a 5.31 per cent gain for the average IA Targeted Absolute Return peer (although it should be noted that the sector is home to a wide range of strategies). The fund has an ongoing charges figure (OCF) of 0.87 per cent.