Tactical Asset Allocator: trade detente sets up market for rally

Easing of trade war tension between the US and China is opening up tempting opportunities for investors.

The rally in the first quarter lifted the US and other markets to a six-month high, while sovereign bond prices have mirrored investors’ renewed confidence by tumbling from their recent two-year peak. The uber-pessimism of the fourth quarter of 2018 has turned into fresh hope that gains can be made when trade wars and Brexit have been pushed out of the way.

Much of the rally is down to progress in the trade talks between the US and China, US president Donald Trump having given Beijing until 2025 to meet a new set of commitments to import US commodities such as soybeans and energy products, and allow US companies to wholly own enterprises operating in China.

Trade war respite

Trump is worried that the trade war is hurting US output as businesses postpone capital spending until they know the rules of engagement for their international supply chains. At the same time, China’s main stockmarket index has shrugged off the dispute by climbing by 34% over the year to date, and although its exports have fallen by more than 20% year on year, the Chinese government’s monetary stimulus is working and its strategy to shift the economy from exporting to providing for domestic consumers is gaining traction.

Goldman Sachs forecasts that the Shanghai Composite target index could rise by 3450 points, which is around 12% higher, led by consumer discretionary sectors such as education, tourism, insurance companies and internet firms.

There are opportunities in the property sector, where some stocks are offering dividend yields of 9-10% and further growth of 10-15% is possible. However, investors will need to watch out for government intervention, as policies that have been supporting property prices could be withdrawn in the latter half of the year.

China’s renewed stability should go some way to reignite smartphone demand – which plummeted sharply in the fourth quarter of 2018 – and in turn lift the big semi-conductor markets in Taiwan, Korea and Japan. A recent survey of data centres, which store and manage data for enterprises, suggests data centres are planning for 15% growth this year and major capital expenditure.

Japan on the rise

The Japanese stockmarket has been particularly fl at, but the nation’s industrial output rose by 1.4% in February, halting a three-month losing streak, as a pick-up in exports helped car manufacturers as well as companies that produce semiconductors and liquid crystal displays. In addition, the yen is weakening – another helpful trend for the nation’s exporters.

Japan has been changing: today it is far more open to foreign investment and immigration. Its workforce peaked last year at 62 million as the ageing Japanese population was reinforced by a substantial intake of foreign workers. The government now plans to introduce a general work visa that will be less onerous to obtain, as it will not require sponsorship by a named employer.

One of the best-known Japanese investment trusts is Baillie Gifford Japan, which outperformed for years under the management of Sarah Whitley, who retired last year. Its house approach is, nonetheless, said to be predominantly team-based, so we are using our spare cash to take a holding in the fund, hoping that the rebound in the export market will benefit holdings such as Sony and Sysmex.

For plays on the indigenous economy, sister trust Baillie Gifford Shin Nippon focuses on small Japanese companies that have good growth prospects. Alternatively, the Legg Mason IF Japan Equity trust is a well-regarded, if higher-risk, concentrated portfolio managed by Hideo Shiozumi, which also has a bias to smaller companies.

China’s recovery will also help Europe, where a revival is already well underway. Institute for Economic Research business climate data for Germany and INSEE data for France both show an improvement. There could be unexpected risk, however, from a deteriorating trading relationship between the US and Germany – car wars – which might hit the headlines.

UK, mired in Brexit dislocation, has seen stuttering consumer confidence reflected in paltry demand for cars, with March sales at a six-year low, despite the month’s traditional strength for new purchases owing to the number plate changeover. Falling consumer demand has also hurt travel firms such as Easy Jet,  and cruise and specialist tour provider Saga, which have warned of a weak summer travel season. A contrarian investor might deem financials and other value areas that have fallen out of favour – because they typically take the brunt of any market meltdown – relatively attractive at current prices.

Emerging market stocks as a whole are at their highest point for six months, but Turkey is troubled politically. Its stockmarket was particularly volatile in the run-up to recent local elections, when it lost 10% of its value in just over a week. At one stage, the Turkish lira fell against the dollar by 5% in a single session. Inflation rose by nearly 20% over the past year and chronic unemployment stands at 13.5%.

Global prospects

Looking ahead globally, news on corporate earnings will be hugely significant. A drip-feed of profit warnings that began with Apple’s announcement in December raises doubts about how much further markets can climb if profitability falters.

According to BNP Paribas, a consensus of economic surveys suggests global growth has been cut by half over the last year, from more than 5% to 2.5%, and predictions of around 3% growth seem reasonable. Some of the disruption in the US is in response to data on unemployment and consumer durables, which is backward-looking and by next month should, with luck, be behind us.

China and Japan funds set to stir sluggish markets

Click here to see larger version of table

 China and Japan funds set to stir markets: table for Tactical Asset Allocator (600)

Notes: *Risk level is produced by FE Analytics and references the FTSE 100 as benchmark of 100. £10 standard interactive investor dealing charge and 0.5% stamp duty deducted from cash holdings on new purchases and sales. Cash at start of period = £3,293.65. Dividends this period: 1,097 NEOA x £3.766 = £41.31; 1,000 JMG x 5p = £50; 100 IHE x $0.556531 = $55.65 = £42.68; total dividends = £133.99. Purchase of 400 Baillie Gifford Japan IT shares at £7.66 = £3,064 plus stamp duty of £15.32 and a dealing of charge £10 = £3,089.32. Cash at the end of the period = £338.32. Source: interactive investor, as at 5 April 2019

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