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Trump-Xi Give Markets the Most They Could Have Expected

Trump-Xi Give Markets the Most They Could Have Expected

Tuesday, 4 December, 2018 - 11:15
Trade truce.
Oh, what a circus. Oh, what a show. Buenos Aires is accustomed to staging political drama. This weekend it provided a stage for China and the US to call timeout on their escalating trade confrontation. Both needed a break, and both needed to show they’d won something, so some kind of accord was very likely.

What they achieved was no more than what many had expected, but it was also the most that anyone could fairly have expected. And it delivered for some important domestic constituencies, such as U.S. soybean farmers. The real risk of a serious downside (an angry confrontation and a meeting ending with recriminations and no agreement) has been avoided, providing a good excuse for anyone who wants to be “risk-on” on Monday to take some extra risks.

That’s about the limit of it. As Diana Choyleva of Enodo Economics figures, this is a truce and not a breakthrough, and provides both sides with 90 days to intensify talks on the most difficult of matters. Such matters are formidable:

- But for Washington, forced technology transfer, intellectual property rights and non-tariff barriers are key
- We expect China to cede ground on the above, but its high-tech leadership ambitions are non-negotiable
- The trade war is likely to morph into a tech war in 2019

The tech war matters a lot. It’s widely understood that the US-China relationship is crucial for the world and will take years to resolve. The widespread review of ancient history, led by Thucydides, in the last week makes clear that investors understand that this is a long-term conflict that moves far beyond economics, and will not be resolved in a hurry. As Win Thin, a currency strategist at Brown Brothers Harriman put it, this could turn out to be a “can kick that will come back to haunt investors in 2019.” That’s about right — one immediate downside risk has been removed, but in the longer term, all the risks remain in place.

And soon we will return to the other underlying problem, which is China’s slowing economy. By Monday morning in Europe and the U.S., we should have the latest PMI figures for China’s manufacturing sector. The last official reading for the Caixin survey was exactly 50.0, the dividing line between expansion and contraction. Any further declines in the PMI would shift concern back from trade and on to China’s stressful attempts to deflate its credit bubble without causing a crash.

Did cutting red tape put stocks in the black?
Beyond the tax cut, Trump’s first year as president had one other very market-friendly development. He promised to cut regulations for businesses, and he delivered in spectacular fashion. Deregulation is hard to quantify, but George Washington University’s Regulatory Studies Center keeps a great website loaded with data. It suggests that when it comes to deregulation, something truly special did happen in Trump’s first year, providing a big-one effect on the private sector.

Take the Federal Register, which is where federal rules have been published since the time of Franklin Delano Roosevelt. In Trump’s first year in office, the register shrunk by the most since President Harry S. Truman was attempting to bring the country off a war footing in 1947.

If we view this in terms of the total volume of regulations, then the rule book is now only as big as it was the latter years of the Carter administration. The Reagan administration engineered a significant reduction in regulations, but not on the scale seen under Trump. Again, viewed this way, the first year of the Trump administration was historically significant.

This is not just about cutting rules already on the books. The pace of new rules introduced, which accelerated under the Obama administration, has collapsed to a level not seen since the second year of Ronald Reagan’s second term. Neither of the Bush administrations ever managed to get through a year with so few new rules put on the books.

The problem is knowing what to make of this trend from an investing standpoint. On a typical list of reasons why stocks did so well in 2017, “deregulation” tends to be mentioned right after “cutting taxes,” and it should almost by definition be beneficial to corporate profits in the short run. Any increase in profitability as the result of a relaxed regulation should stay in place, but this would be a one-off impact on growth, the effects of which we have presumably felt in the startlingly good numbers reported by corporate America this year.

The problem is that it can be very hard to map the impact of deregulation. It is not part of standard earnings models, and the initial impact will occur on a company-by-company basis. Management, its auditors and institutional investors should understand the effects of a rewritten rule. Others may not. It is a good bet that some of the surprise element from the huge US profit increases this year, not seen elsewhere, came from deregulation. As such, this low-hanging fruit has been picked, and there will be much less deregulation over the rest of the Trump presidency.

Another issue is whether too much deregulation has taken place. If you read Michael Lewis’s latest book, “The Fifth Element,” you might agree that with that there has, and we may live to discover that some of this excessive regulation did us good as a society. For now, though, the point is that deregulation has been real, not just a Trumpian brag, and its impact is probably not fully understood.


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