Bedrock’s Newsletter for Friday 29th of November, 2019

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 Friday, 29th of November 2019

“It’s tangible, it’s solid, it’s beautiful. It’s artistic, from my standpoint, and I just love real estate.”

– Donald Trump

 

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Markets made gains this week as optimism grew that a phase-one US-China trade deal can be struck in time for Christmas. Swings in global trade sentiment have been the principal driver of equity market volatility for the past two years and the prospect of a ceasefire between the two superpowers has lifted spirits and stocks (once more). On Monday, the Chinese state-backed Global Times newspaper – often seen as a mouthpiece for the Communist Party to float policies with domestic audiences – claimed that China and the US are “moving closer to agreeing” a trade deal, while reports elsewhere suggested that Chinese negotiators had promised to beef up the country’s protection of foreign IP as a sop to the US. On Wednesday, President Trump went so far as to say that the two sides were in the “final throes” of negotiations; markets bounded higher in response. Trade-linked sectors such as IT and semiconductors have led the US rally as the risk-on mood pushed the S&P 500 Index higher every day this week.

 

The problem is that we have been here before, with reports suggesting that a trade deal was imminent just as talks collapsed and tariffs were hiked in April. The stars may favour a US-China trade deal, now that its scope and ambition have been narrowed and given the tariff-fatigue in the US and elsewhere. However, there is no way to know what obstacles remain to a deal’s conclusion in the coming weeks. For example, one side may be trying to bounce the other into agreeing certain terms, or their favoured implementation timetable, through public statements designed to build momentum behind their position and put pressure on negotiations. There is also the wild card of the Hong Kong protests. Pro-democracy candidates crushed pro-Beijing parties in district council elections last weekend, capturing 392 out of 452 seats and sending a clear message to the Hong Kong legislature about where public sympathies lie. America also weighed in this week as the Donald ratified a bill that promises to make the territory’s special trade relationship with the US dependent on its freedom and autonomy from China – this earned the US a sharp rebuke and muddies the outlook for talks. With all this in mind, we will be maintaining our defensive posture: it is better to have a hedged exposure to a rally than an unhedged exposure to a sell-off.

 

Another reason to stay defensive is the dire position of the Eurozone economy amid the slump in global trade and investment. In previous newsletters, we have spoken at length about Europe’s vulnerability to the trend towards de-globalisation and the onshoring of supply chains given the relative openness of the continent’s economies. For example, the value of German trade is equivalent to 87% of GDP versus just 27% for the United States. OECD data published on Thursday shows the impact of Europe’s global trade exposure in the third quarter alone. During Q3, the block’s exports were down -1.8%, while G20 exports as a whole fell -0.7%. Imports took less of a hit, down -0.4%, but in growth accounting this does nothing to help headline GDP. Moreover, trade contracted across all major EU economies with exports and imports, respectively, down by -0.4% and -1.8% in Germany, -3.6% and -1.7% in France, and -1.2% and -1.0% in Italy. The UK was also hit hard (in large part thanks to ongoing Brexit uncertainty): exports collapsed -3.3% and imports fell -1.6%. Although the signing of an interim US-China trade deal could spark a brief recovery in global trade volumes, phases two (and three) of the negotiations are yet to come and will be much more challenging. Meanwhile, the US has made it clear that the EU is next in line after China for a fight over trade policy. Looking ahead then, the trend is clearly unfavourable for economies which depend so heavily on cross-border flows. Think about it, if you were to start a business today would you really opt for a slightly cheaper foreign supplier in the knowledge of where politics in the West is heading? How you position portfolios and trade around de-globalisation successfully is a vital task for investors today – and one that our more defensive stance is an attempt to address.

 

One market where there were some clear green shoots this week was US real estate. On Tuesday, government agencies released a raft of new housing data for October which showed that sales of new single-family homes hit an annualised (and seasonally-adjusted) rate of 733k for the month. This is well-ahead of expectations and a full +31.6% higher than in October 2018. The September figures were also revised higher from 701k to 738k, which is the highest level of new home sales in over 12 years. Rate cuts this year appear to have turbocharged the US housing market after a difficult 2018, when concerns about trade, geopolitics and the rising cost of mortgage payments did much to strangle demand. Given that, for most Americans, the bulk of their wealth is invested in residential property, a buoyant housing market is good news for Donald Trump ahead of next year’s election. The feel-good factor and wealth effects associated with rising house prices should support consumer demand, the broader US economy and the Trump campaign. (A positive revision of Q3 GDP, from 2.0% to 2.1%, also bolsters the idea of a more robust US consumer and economy than many were expecting to see in the closing months of the year.) We see this US housing data as good short-term news for an asset class – real estate – which we favour on a medium-to-long-term view as well. With global bond yields on the floor and QE infinity the mantra in Europe, yields available on select commercial and residential properties (and real estate portfolios) can be highly attractive. We particularly favour special situation investments and off-market transactions where significant capital gains can also be achieved.