The bull run in the global stock/bond ratio has matured and has been undergoing an extended topping out process since early-2018. The ratcheting up of the U.S./China trade war has increased the risk of the next bear market, something central banks are aggressively trying to prevent.
Although the clash between trade policy and monetary reflation has fattened the upside and downside tail risks for the global economy and equity markets, it has not been symmetrical as the downside risks are larger at this point in the cycle.
The downside economic and equity threat is associated with a continuation of the trade war that leads to the downturn in global manufacturing activity infecting the service sector, and eventually a retrenchment in consumption. Last week’s escalation in the war between the U.S. and China is worrisome. President Trump has every reason to de-escalate, as it has become evident in recent weeks that economic confidence among Republican voters is slipping – a potentially ominous development for Trump’s re-election prospects. Investors should avoid making major directional bets until trade uncertainty diminishes. Those with flexible mandates should focus on risk asset pair trades and currency crosses that neutralize economic cycle risk, and use stops to limit risk on selective directional bets. Less nimble or longer-term investors should limit pro-growth exposure and further reduce exposure on strength or escalating trade tensions.