(20 November 2019)DAILY MARKET BRIEF 2:Global trade: Route to de-escalation

According to media reports, provisions on commodity purchases, market access to financial services, and currency transparency have been completed. The amount of Chinese purchases of US agricultural goods remains a point of controversy, as Beijing refuses to commit on a specific amount but rather buy based on market conditions .

A Phase 1 deal could include policies and an enforcement mechanism concerning intellectual property. The key concerns the US administration has raised, including technology transfer, industrial subsidies, and cybertheft, will likely be left for a subsequent phase.

To better understand the potential outcomes in trade negotiations and their implications for investors, CIO define three major scenarios over their tactical investment horizon of six to 12 months:

Our base case (60% chance): Status quo following initial deal

In our base case, we now see the US and China agreeing a Phase 1 deal that, at a minimum, averts additional tariffs. It is no longer our base line that the US will impose duties on USD 160bn worth of Chinese products as scheduled on 15 December. In our view, the initial agreement would likely include a resolution of less critical issues such as China's purchases of US agricultural products and opening up of its financial services sector, as well as improving the transparency of its currency regime.

The likelihood of a comprehensive trade agreement being reached in subsequent phases over the next 12 months is low in our view. The remaining core issues around Chinese industrial and market practices are difficult to resolve and would likely require the modification of Chinese laws.

Our downside scenario (20% chance): New breakdown in trade talks with tariff increase

This could happen if Trump becomes less convinced of Beijing's commitments, such as increasing China's purchases of US products. We think the president would see having no deal to be better for him politically than reaching a deal that the public perceives to be weak.

Our upside scenario (20% chance): Trade talk momentum builds with tariff removal

As the US administration has announced, US and Chinese negotiators will start to work on subsequent phases of the trade deal immediately after signing a first partial deal. In our upside scenario, both sides quickly resolve core structural issues such as forced technology transfer and Chinese subsidies.

Investment conclusions

Given lower risks of a further breakdown in trade negotiations ahead of the US election, we have closed our underweight position on emerging market equities. If the US and China are able to quickly agree on a meaningful rollback of the tariffs that were applied over the past 18 months, we would expect equity markets to continue to rise, supported by higher earnings and a further rerating of valuations. Global equities could return between 5% and 10%. Overall, a good way to protect against a more protectionist world is to diversify globally and to add regions that generate a high proportion of their revenues domestically. In this context, we prefer the US equity market over that of the Eurozone.