Nothing short of a trade war
03 April 2018
David Lewis of FIS explains that as stock markets continue to rise, so too has the temperature of the rhetoric between the US and China
Image: Shutterstock
Much has been written and broadcast about the economic recovery that is said to be taking place around the globe. Talk has been of growth and a return to prosperity after years of interest rates at record lows and world economies suffering the post-financial crisis blues. The US Federal Reserve, along with the Bank of England, have been confirming not just their plans to raise rates this year, but in fact, to accelerate those rate rises in a move designed to squeeze off any inflationary effects the growing economic recovery may bring. The recent tax cuts in the US are likely to be a factor in those decisions as companies use some of their windfalls to raise employee wages, or deliver one-off bonuses. In the UK, the Monetary Policy Committee has left base rates at 50 basis points, but indicated that the expected increases could start as early as May. This brought positive news for the GBP on the currency markets, but perhaps not such good news for indebted consumers.
While booming stock markets do not necessarily correlate directly with a strengthening economy, rising share prices indicate the market’s expectation of future value or income. On the same day in January 2018, the Hang Seng and S&P 500 both hit five-year peak levels, at 33,154 and 2,872 respectively. The Eurostoxx 600, three days earlier, also hit a recent peak of 402.8, just eleven points below its previous five-year high of 413.6. All three indexes have been on extended bull runs; the Hang Seng and Eurostoxx broadly since the start of 2016, while the S&P has been rising, with a brief hiatus in 2015, for the last five years straight.
However, the end of January brought the bull run across all three market measures to a shuddering halt. Since the January peak, the Asian market, as indicated by the Hang Seng, has fallen by 8.5 percent as of last week’s close (23 March). The Eurostoxx 600 has fallen by 9.2 percent from its January peak to 23 March, but the S&P 500 has lost the most—dropping 10 percent between 26 January and 23 March. Putting that into context dampens the impact slightly. These drops return the S&P to levels seen as recently as last November, with the same levels seen for the Hang Seng three times already this year—in January, February and March. Prior to that, the index briefly exceeded 30,000 in November 2017, in line with the point the S&P has retreated to.
For the European markets, the index volatility matched the Asian fluctuations, matching the low points in February and March, but you would have to look back as far as August 2017 to reach the same level prior to January, suggesting that the European market has fallen further back down the growth curve than its Eastern and Western competitors. The threat of interest rate rises is only part of the story, however. As stock markets have been rising, so, more recently, has the temperature of the rhetoric between two of the world’s largest economies, that of the US and China.
The US has applied tariffs to imports of steel and aluminum, levying 25 and 10 percent to each, respectively. The rules exclude Canada and the EU, which include some of its largest trading partners; but notably, it applies to China, where talk of various tariffs on around $60 billion of trade have been mooted. China has responded with threats of like-for-like tariff application, meaning that if both parties carry out these threats, a full-on trade war will ensue. Modern economic theory would indicate that growth comes from the removal of trade barriers across the globe, but these arguments between the economic superpowers are not about growth, but more about domestic economic policy on the one side and the protection of exporting strength on the other. At the time of writing, there seems to be little chance that either side will back down and an escalation will bring a negative impact to trade, globally—not just between the main protagonists.
When a single company share is believed to be overvalued, short sellers move in to take advantage of the price correction that they expect to come. The same is true, by extension, for entire markets or even countries. Looking at equity borrowing across the three regions as a proxy for short interest activity suggests that there is a rapidly increasing level of negative sentiment in the markets, although it is not at the same intensity across all three zones. Over the last 15 months, from December 2016 to March this year, specifically, equity borrowing by value has risen in Europe, the US and Hong Kong, with Hong Kong being identified in this context specifically as a proxy for Chinese equities listed in the province.
When compared on an indexed basis, applying 100 to December 2016, Europe has seen growth in short interest that is, by far, the highest of the three markets. By March 2018, the value of shares on loan across Europe had advanced some 87 points. Over the same period, the Eurostoxx 600 had advanced just 1.6 percent, making the component impact of rising prices across the period, negligible. Over the same period, the value of US equities borrowed has risen 31 points, with the S&P 500 index rising a net 14 percent over the period, suggesting that rising share prices may have accounted for approaching half of that increase.
Shares in Hong Kong appear to have suffered the least, in terms of increasing short interest. The value of borrowed shares has risen 54 points over the last 15 months, but the Hang Seng has advanced just over 40 percent over the same period, suggesting that the uplift in actual shares shorted is the same, or just less than that in the US. Figure 1 shows the indexed values of borrowed shares across the three markets over the last 15 months.
With the potential for a trade war between two economic superpowers, both have seen their share values impacted, and both are seeing net rises in short interest activity. However, it appears that neither are facing such significant increases as are being seen across the Eurozone, indicating that hedge funds and other investors on the short side of the market are expecting a more dramatic correction across the European trading block than they might be envisaging between the increasingly aggressive economic titans.
Figure 1: Equity borrowing Indexed to December 2016
Source: FIS’ Astec Analytics
While booming stock markets do not necessarily correlate directly with a strengthening economy, rising share prices indicate the market’s expectation of future value or income. On the same day in January 2018, the Hang Seng and S&P 500 both hit five-year peak levels, at 33,154 and 2,872 respectively. The Eurostoxx 600, three days earlier, also hit a recent peak of 402.8, just eleven points below its previous five-year high of 413.6. All three indexes have been on extended bull runs; the Hang Seng and Eurostoxx broadly since the start of 2016, while the S&P has been rising, with a brief hiatus in 2015, for the last five years straight.
However, the end of January brought the bull run across all three market measures to a shuddering halt. Since the January peak, the Asian market, as indicated by the Hang Seng, has fallen by 8.5 percent as of last week’s close (23 March). The Eurostoxx 600 has fallen by 9.2 percent from its January peak to 23 March, but the S&P 500 has lost the most—dropping 10 percent between 26 January and 23 March. Putting that into context dampens the impact slightly. These drops return the S&P to levels seen as recently as last November, with the same levels seen for the Hang Seng three times already this year—in January, February and March. Prior to that, the index briefly exceeded 30,000 in November 2017, in line with the point the S&P has retreated to.
For the European markets, the index volatility matched the Asian fluctuations, matching the low points in February and March, but you would have to look back as far as August 2017 to reach the same level prior to January, suggesting that the European market has fallen further back down the growth curve than its Eastern and Western competitors. The threat of interest rate rises is only part of the story, however. As stock markets have been rising, so, more recently, has the temperature of the rhetoric between two of the world’s largest economies, that of the US and China.
The US has applied tariffs to imports of steel and aluminum, levying 25 and 10 percent to each, respectively. The rules exclude Canada and the EU, which include some of its largest trading partners; but notably, it applies to China, where talk of various tariffs on around $60 billion of trade have been mooted. China has responded with threats of like-for-like tariff application, meaning that if both parties carry out these threats, a full-on trade war will ensue. Modern economic theory would indicate that growth comes from the removal of trade barriers across the globe, but these arguments between the economic superpowers are not about growth, but more about domestic economic policy on the one side and the protection of exporting strength on the other. At the time of writing, there seems to be little chance that either side will back down and an escalation will bring a negative impact to trade, globally—not just between the main protagonists.
When a single company share is believed to be overvalued, short sellers move in to take advantage of the price correction that they expect to come. The same is true, by extension, for entire markets or even countries. Looking at equity borrowing across the three regions as a proxy for short interest activity suggests that there is a rapidly increasing level of negative sentiment in the markets, although it is not at the same intensity across all three zones. Over the last 15 months, from December 2016 to March this year, specifically, equity borrowing by value has risen in Europe, the US and Hong Kong, with Hong Kong being identified in this context specifically as a proxy for Chinese equities listed in the province.
When compared on an indexed basis, applying 100 to December 2016, Europe has seen growth in short interest that is, by far, the highest of the three markets. By March 2018, the value of shares on loan across Europe had advanced some 87 points. Over the same period, the Eurostoxx 600 had advanced just 1.6 percent, making the component impact of rising prices across the period, negligible. Over the same period, the value of US equities borrowed has risen 31 points, with the S&P 500 index rising a net 14 percent over the period, suggesting that rising share prices may have accounted for approaching half of that increase.
Shares in Hong Kong appear to have suffered the least, in terms of increasing short interest. The value of borrowed shares has risen 54 points over the last 15 months, but the Hang Seng has advanced just over 40 percent over the same period, suggesting that the uplift in actual shares shorted is the same, or just less than that in the US. Figure 1 shows the indexed values of borrowed shares across the three markets over the last 15 months.
With the potential for a trade war between two economic superpowers, both have seen their share values impacted, and both are seeing net rises in short interest activity. However, it appears that neither are facing such significant increases as are being seen across the Eurozone, indicating that hedge funds and other investors on the short side of the market are expecting a more dramatic correction across the European trading block than they might be envisaging between the increasingly aggressive economic titans.
Figure 1: Equity borrowing Indexed to December 2016
Source: FIS’ Astec Analytics
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