Political events could trigger volatility in 2019. However, the markets should not underestimate the possibility that the U.S. and China will be able to resolve their trade dispute.
Political risks are adding to uncertainty, including the unresolved issues surrounding the U.S. and China trade dispute.
Other lingering risks include Brexit, Italy, and U.S. politics, any of which could trigger renewed volatility in 2019.
A number of political risks have the potential to disrupt global markets in 2019, with perhaps the most serious being the danger of a trade war between the U.S. and China. Moves by the Trump administration to raise tariffs on Chinese goods, plus Beijing’s retaliatory measures, already have taken a toll on U.S. stocks that rely on China‑related revenues. While the top China‑oriented stocks in the S&P 500 outperformed the index by a considerable margin in 2016 and 2017, much of that return advantage quickly disappeared after trade tensions rose to a boiling point in the summer of 2018. Although President Trump and Chinese President Xi Jinping agreed in early December to a temporary halt to tariff increases set for the end of 2018, the underlying issues remained unresolved. T. Rowe Price economists estimate that higher tariffs on Chinese exports could do real, but manageable, damage to the U.S. economic expansion.
However, they add, the 2019 outlook would turn darker—both for the U.S. and the global economy—if the Trump administration were to follow through on its threats to impose tariffs on all foreign auto and auto‑part imports. Giroux thinks markets should not underestimate the possibility that the U.S. and China ultimately will be able to settle their trade dispute. Beijing, he argues, has signaled its willingness to accommodate the U.S. in some areas, such as tariff cuts, safeguards for intellectual property, and increased purchases of U.S. goods and services. “The question is whether that will be enough for the Trump administration,” Giroux says. Some of President Trump’s advisors, Giroux says, may not trust China to comply with any deal. Others may believe criticizing China would be smart politics in the runup to the 2020 presidential election. Still, he adds, given the economic benefits and the boost a successful deal could give to asset valuations, there also are strong political incentives for Trump to compromise.
TRADE FEARS HIT CHINA-RELATED STOCKS Relative Returns on S&P 500 Stocks with Highest China Revenue Exposure Through October 31, 2018
Sources: Strategas Research Partners. T. Rowe Price analysis/calculations using data from FactSet Research Systems Inc. All rights reserved. Performance shown for stocks with the highest China exposure consists of an equal-weighted portfolio of the 15 companies in the S&P 500 Index with the greatest proportion of total revenues generated in China, as of August 27, 2018.
A number of other geopolitical developments could trigger renewed volatility in 2019, T. Rowe Price investment professionals say. These risks include:
Brexit: While the UK government and EU leaders have agreed on the technical terms of Britain’s exit from the EU, the narrow path to resolution suggests that the key issues will complicate the UK–EU relationship for years to come. While negative headlines have weighed on investor sentiment, a successful deal would give a considerable lift to UK assets, particularly the British pound, Thomson says.
Italy: The populist coalition that took power in 2018 has put forward a fiscal stimulus plan that exceeds EU deficit limits, bringing it into conflict with EU authorities. However, market measures of default risk suggest those fears have not—as yet—spread to other peripheral euro countries such as Spain and Ireland. “This tells us the markets believe the tail risk of a dissolution of the single currency is still limited at this point,” Thomson says.
U.S. Politics: Although the Democratic Party regained the majority in the lower house of the U.S. Congress in November’s elections, Giroux calls the result “a nonevent, or at least a neutral event,” since the Senate remains in Republican hands.
The main event, he says, will be the 2020 elections, when the House, the Senate, and the presidency all will be at stake.