UBS: The market is now at 'peak fear' over the threat of a US-China trade war

Thomas Peter/Reuters

• Markets may have hit "peak fear" when it comes to the threat of a trade war between the USA and China, according to analysts from UBS.
• Stocks have swung wildly on developments around tariffs imposed by the US and China against one another.
• But given the lack of clarity over the so-called trade war, markets in Europe in particular, have more important things to worry about.

LONDON - Markets may have hit "peak fear" when it comes to the threat of a trade war between the US and China, and will react less aggressively to future developments as a result, analysts at Swiss lender UBS argued on Monday.

Writing after a week in which European equities fell sharply before rallying, a team of strategists led by Nick Nelson and Karen Olney argued that attention given to trade has likely reached its highest point, and should subside, with markets refocusing themselves on the fundamentals of Europe's recent growth.

"The threat of "trade wars" is another concern driving equities. There is little clarity at the moment, but media coverage suggests we may have hit 'peak fear'," the team said in a note dated April 9.

Equity markets dropped sharply early last week after the USA and China exchanged tit-for-tat announcements about tariffs on hundreds on billions of dollars of goods, with European stocks dropping as much as 1.5% during trading on Wednesday.

Those concerns have hit Germany's stock markets the hardest, given that it is Europe's biggest economy, and relies heavily on exports.

"Within Europe, Germany has underperformed recently - the DAX is down 9.3% from the 23-Jan peak and has underperformed the Euro Stoxx 50 by 2.7% YTD," the UBS team said.

"This may be because of concerns about the exposure of the economy and the stock market to global trade and some of the potentially exposed industries, such as steel and autos."

The problem for the markets in such scenarios is that with volatile actors like President Trump, it is difficult to predict with any kind of certainty what will happen in the future, so investors tend to immediately assume the worst case scenario in the case of negative developments (i.e. a full-blown trade war) and the opposite when there are positive developments. This can create big swings in market prices.

"Equity markets tend to struggle to price in the small probability of a very negative event occurring," UBS said.

"If we were to see an all-out trade war between the US and China, with the EU involved as well, it could lead to dramatically lower global trade and ultimately, a sharp economic slowdown. However, it is not clear that is the most likely path from where we stand today."

The analysts point to the fact that while announcements have been made, there has been no real substantive action so far, and that as a result the direct impact of the skirmish has been fairly inconsequential

"To date, the direct effects of the measures have been relatively minor (UBS expects a c.10bps drag to Chinese GDP) with many potential exclusions on the US side and a 'proportional' response from China," the analysts said.

They urged caution, however, noting that "this is clearly a live issue though with further comments from the US administration on Thursday."

"Certainly the media coverage of 'trade wars' appears to have hit a multi-year peak," they added, pointing to the chart below:

UBS

With the market hitting "peak fear" of a trade war, UBS said, European investors are soon likely to refocus their attentions on what appears to be the slowing momentum of the continent's economic growth.

A series of weak PMI data last week has sparked concerns, with UBS noting that european equities "are now down 6.6% from their January peak and down 3.4% year to date. The initial sell-off was driven by higher inflation and sharply rising bond yields. But that has now morphed into concerns over PMIs rolling over."

Investors shouldn't be too worried, however, with the team arguing that "the level of the PMIs are still high (the composite PMI is 55.2) and suggest strong economic growth."

"In Goldilocks terms, the fear is now that the porridge is not too hot, but too cold," UBS said.