Trade talks suffered a major setback recently when China proposed extensive revisions to a draft agreement with the US. US President Donald Trump retaliated with higher tariffs on Chinese goods, sending the S&P 500 off its record high. Kristian Camenzuli answers investors’ typical questions on the trade war.

Since the start of the year, the S&P 500 rallied an impressive 18 per cent before trade war concerns re-emerged. A major contributor to this positive performance was the expectation that President Trump and President Xi would sign a trade deal at the G20 summit, which will be held end of June.

However, the trade talks suffered a major setback last week when China proposed extensive revisions to a draft agreement, sending equity markets lower. Nonetheless, both China and the US continue to remain cautiously optimistic that a deal could be reached.

What went wrong?

China wanted to delete prior commitments that Chinese law would be changed to enact new policies on issues from intellectual property protection to forced technology transfers. Instead, the Chinese negotiators argued that they could accomplish the policy changes through decrees issued by its State Council, or Cabinet.

How did the US retaliate?

The US increased tariffs from 10 per cent to 25 per cent on $200 billion worth of Chinese goods.

For how long will the tariffs remain in place?

Larry Kudlow, the White House economic adviser, said the tariffs will remain in place until the Chinese adopt the corrections in an agreement which is codified by law in China.

How did China retaliate?

Small setbacks are normal and inevitable

China will hike tariffs on $60 billion worth of US imports, starting on June 1, when it would raise tariffs to as high as 25 per cent on more than 5,000 US products. The new Chinese duties target a wide range of agricultural products, and US farmers are set to be hardest hit.

Nonetheless, Liu He, China’s chief negotiator in the talks, said: “Negotiations have not broken down. Quite the opposite, small setbacks are normal and inevitable during the negotiations of both countries. Looking forward, we are still cautiously optimistic.”

Does the US have further tariff threats in the pipeline?

Yes. In response to China’s new tariffs, the US may impose another raft of levies on an additional $300 billion worth of Chinese goods.

When is the next meeting between the US and China?

There is a ‘strong possibility’ that Trump will meet Chinese President Xi at the next G20 summit in Japan scheduled for late June.

How will the tariffs impact China’s growth forecasts?

The increase in tariffs would likely drag down the country’s Gross Domestic Product growth rate by 0.3 to 0.5 percentage points over the next 12 months. That would slow China’s economic growth pace this year to between six and 6.2 per cent, but still within the government’s target range of six to 6.5 per cent for 2019.

Will the Federal Reserve cut rates in 2019?

Fed funds futures are pricing in a 100 per cent chance of a quarter-point rate cut by December, and even a 60 per cent chance of a cut by September. By the end of next year,the market expects at least two rate cuts.

Trump had called for a Fed interest rate cut. He criticised the central bank and said it was holding back the economy.

Do you think a deal may still be reached?

Yes. China and the US both have the ‘ability and wisdom’ to reach a trade deal that is good for both.

We remain optimistic on the prospects of both sides reaching an agreement, although it is not going to be done in the time frame originally anticipated.

It is just high stakes poker right now, and both sides are going to have to figure out how to come to a compromise.

What if a deal is not reached?

In the event of a complete breakdown in the talks and higher tariffs, we would expect to see US stocks markets trade 10 to 15 per cent below their highs and an even higher fall in the Chinese markets. However, this is not our base case scenario.

What’s your outlook on the equity markets?

We remain cautiously optimistic about the equity markets generally in the medium to long term.

In China we started to see a positive turnaround in economic data despite tariffs already in place. This is mainly due to the stimulus package put in place by the Peoples’ Bank of China (PBOC) in the summer of 2018. Given the latest round of tariffs, we expect additional stimulus measures from the PBOC in the coming months, which should mitigate part of the increase in tariffs and seen as a positive by investors.

In Europe, we expect companies to benefit from any stimulus measures made by the Chinese due to their dependence on the Chinese consumer. We also do not rule out further trade agreements between the Chinese and Europe. We also expect an improvement in economic data out of Europe in the second half of the year which should reflect positively in equity valuations.

The US market on the other hand is dependent on the US consumer – 70 per cent of US GDP comes from US consumption. The latest round of tariffs will put the US consumer at a disadvantage as a number of products including cellphones and laptops will also be included. It is in their interest to strike a deal with China.

Be patient. In the medium term, equity markets should continue to generate positive returns for shareholders. Alibaba’s Jack Ma once said, “the US-China trade war is the stupidest thing in the world!”

Kristian Camenzuli is invest-ment manager at Calamatta Cuschieri.

The information, views and opinions provided in this article are provided solely for educational and informational purposes and should not be construed as investment advice, tax or legal advice. This article was issued by Calamatta Cuschieri Investment Services. For more information visit https://www.cc.com.mt/.