Daily Comment (October 8, 2019)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

Equities are weaker this morning two days before China/U.S. trade talks.  Uncertainty reigns on the Syria/Kurd issue.  Brexit looms. Here are some of the details:

China:  There are two news items regarding China that have sent equities lower.  First, the U.S. has added 28 Chinese entities to the “Entity List”, including eight companies and 20 public security bureaus.  This action is tied to the suppression of Muslim minorities.  The U.S. has indicated that this action is unrelated to the trade talks, but it’s hard to see how China will not tie the two together.  It seems as though the White House either wanted the action to signal a hard line on upcoming negotiations, or this is an “own goal”.  China has indicated it will respond to the U.S. action.  Second, the administration is considering adding limits on pension fund investments in Chinese stocks.  Although this isn’t as aggressive as a move to force delisting, it will limit the ability of Chinese companies to tap the U.S. financial system.  In addition, there are reports that the U.S. is considering rules limiting the ability of indexes to own Chinese stocks.  Also under consideration is a move to block U.S. investments into China.

It is hard to see how these moves will facilitate a good outcome from Thursday’s talks.  The Chinese delegation has already indicated it will cut its visit short by one night.  As we noted yesterday, we have perceived a general notion among equity investors that some sort of deal will get done to get a “win.”  Perhaps, but the well looks rather poisoned at this point.

In addition to the trade friction, further evidence emerged of rising tensions between the two nations.  First, the NBA found itself in China’s crosshairs after an official with the Houston Rockets offered public support for Hong Kong protestors.  The NBA, fearful of losing access to what has been a growing market, began backing away from the comments, with the Rockets ownership apologizing for the tweets.  The NBA isn’t the only American entity backing away from criticizing China.  Car companies have apologized for offending China by using the Dali Lama in advertising.  Airlines no longer show Taiwan as a separate entity.  However, one profile in courage has emerged, the founders and writers of South Park.  After an episode of the show criticized China for its censorship practices, China blocked the cartoon from its airwaves.  The creators of South Park responded with a mock apology dripping with satire.

We may still see a deal this week, but it appears to us that the odds of one are falling.

Syria:  In the immediate term, it isn’t entirely clear what is going on with Syria in the aftermath of President Trump’s decision to withdrawal from the Kurdish zone in northern Syria.  After the president indicated his intentions, he was showered with negative comments from GOP senators, a rare rebuke from this group.  As the White House took criticism from these circles, the president tried to walk back the withdrawal, threatening economic sanctions if Turkey did something the U.S. opposed.  The TRY fell on the news.  Meanwhile, if the U.S. is going to stand in the way of Turkey, it doesn’t appear that Ankara got the memo, as Turkish troops are preparing to invade.   As noted above, it isn’t clear what the near term U.S. strategy is on this issue.  However, the long-term strategy is crystal clear, and has been consistent for the last two administrations; the U.S. is getting out of the Middle East and a power vacuum is almost certain.

Brexit:  It is now clear that the Brexit talks are dead.  Instead of touring European capitals to negotiate the Irish border, PM Johnson is preparing for elections.  MPs have been trying to find some sort of middle ground between a hard Brexit and remaining.  This middle ground has proven to be elusive, and U.K. voters are likely to face a stark choice; hard Brexit, or a Corbyn led government.  This unappealing choice has been evolving for the past two years.  The path?  We expect Brexit to be delayed, new elections to be called and we will see which of these outcomes the voters favor.  In the short run, it likely means a weaker GBP.

United States-Russia:  House Foreign Affairs Committee Chairman Engel said yesterday that the Trump administration is considering a U.S. withdrawal from the “Open Skies” treaty of 2005, which allows signatories to make surveillance flights over each other’s territory.  While some lawmakers have complained that Russia is using overly-intrusive cameras on the flights, and isn’t providing reciprocal access to the United States, others are concerned that a withdrawal would mark the third major arms-control agreement ended or put at risk by the administration.

Odds and ends:  The U.S. and Japan have finalized a trade deal.  Four EU nations agree on a migrant relocation program.  The U.S. is taking steps to protect U.S. tech firms from foreign regulation.  This is happening at the same time as more state attorney generals are looking to expand the group investigating the same firms.

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