Trade threats from China take a toll on global stocks

China’s threat to impose counter-measures in retaliation for the latest US tariffs knocked stocks on Thursday, checking earlier attempts to recover from a rout sparked by fears of a world recession.

Wall Street futures erased earlier losses and were trading in positive territory. But the relentless drop in global bond yields raised fears the world economy was hurtling towards recession and weighed on global equities.

Expectations the US Federal Reserve and other central banks would respond to the recession warning helped stocks to steady earlier. But that recovery was cut short by the latest rhetoric emerging from Beijing, Reuters reported.

“The only game in town is the central banks, hence the bond markets are rallying,” said Peter Schaffrik, global macro strategist at RBC Capital Markets.

“We have regional bonfires in Hong Kong, Argentina, Japan against South Korea, and none of these are going away easily. Each and every one is not necessarily strong enough to cause trouble.”

The curve has inverted before every recession in the past 50 years and sent a false signal just once

Recession fears grew on Wednesday after yields on 10-year Treasury bonds dropped to less than twoyear rates for the first time in 12 years, when the same yield curve inversion presaged the 2008 recession, the report said. The curve has inverted before every recession in the past 50 years and sent a false signal just once.

The latest inversion has since reversed, albeit marginally, and yields on 30year Treasuries rose off the record 1.965 per cent low reached in Asian trade. However, they are still down 60 basis points in just 12 sessions.

“We have seen stocks trading very poorly as a result of the yield curve inversion, so that will be flashing some additional warning lights for the Fed that they have to do more,” said Andrea Iannelli, investment director at Fidelity International.

“The only question is, can the Fed out-dove the market? At the very least they will have to match market expectations in the short term.”

The Chinese comments sent a pan-European equity index down more than half a per cent and markets in London and Frankfurt lost more than 1 per cent. Earlier, Asian shares fell 0.5 per cent.

An inverted yield curve may be a recession portent and evidence of generalised market chaos, but it is no reason to cut and run in equities, was the near-unanimous view of professional equity managers.

While someone was obviously hitting sell on Wednesday, sending the Dow Jones Industrial Average to its worst day of the year, it wasn’t these investors, who while trying to insulate their portfolios said they were not bailing. For the most part, fear of missing out continues to overpower fear of getting decimated.

“People believe that is going to cause a recession, that it’s only a matter of time. And in fact, what we find is that it takes quite a long time,” said Mariann Montagne, a fund manager at Gradient Investments, which oversees $2.3 billion (Dh8.44bn). “We have a lot of money to make between now and then.”

The basis for their gripe is the sudden obsession with the relative altitude of interest rates. Yield curve inversion, while an ominous sign, did not exactly sneak up on anyone, they note, while concerns about slowing growth, the Federal Reserve and trade with China began buffeting markets months ago. It was back then that Lamar Villere, a portfolio manager at Villere & Co, was raising cash and adding low-volatility stocks.

“We’re not bailing, and we’re not expecting all of a sudden something magic to happen,” said Mr Villere, who helps to manage around $2bn. “I don’t think anything fundamentally has changed for us based on the yield inversion.”

Managers with a longer-term horizon said the plunge, if anything, creates an opportunity to buy stocks. Jason Browne, president of Alexis Investment Partners, did just that in the past several days, using money he raised in July when markets were at an all-time high.

“It doesn’t mean I don’t own things like gold or more defensive positions that I can get more aggressive with,” Mr Browne said. “I’m more of a buyer within the context that when I look across the positions I own, they’re all things that I feel like I can trade around.”

When the spread between two and 10-year Treasury yields flipped 10 times since 1956, it preceded recessions. But never right away. The S&P 500 topped out anywhere from two months to two years later, data compiled by Bank of America strategists show. Gary Bradshaw, a portfolio manager at Hodges Capital Management in Texas, is also a buyer.

“Just because the 10-year is less than two-year, it doesn’t preclude me from adding to the Microsofts, Visas and Paypals of the world,” said Mr Bradshaw, who helps to oversee $1.5bn at Hodges Capital Management. I’ve been sitting here buying attractive stocks that are beaten up, and I will continue to do that.”

For months, trade tension has been souring and signs that global growth is slowing have been cropping up. Angst was sparked anew on Wednesday after data showed Germany’s economy shrank in the second quarter and Chinese retail and industrial numbers came in below expectations.

To Ed Keon, a managing director and portfolio manager at QMA in New Jersey, that is a signal stock prices can go lower. He has been cautious and kept a neutral to slight underweight stock position. Now he is waiting for a further drop to add to his portfolio.

“Prices aren’t to the point yet where they are just compelling, but the data today with the industrial data coming out of about Germany’s economy and Chinese industrial numbers wasn’t all that great,” said Mr Keon. “We aren’t planning on making major portfolio changes until the prices are compelling.”

Timing the stock market decline following a yield curve inversion is a task for the brave of heart. Six of the past 10 times the yield curve flipped, the S&P 500 rolled over within three months. In the other four, the gauge did not top out until at least 11 months later.

Marshall Front, the chief investment officer at Front Barnett Associates in Chicago, is taking no chances timing the market decline. He reduced his stock position by about 2 percentage points oneand-a-half months ago, not out of growth concern but because one of his positions started looking less attractive.

“Having a substantial equity exposure is still warranted, even though we have clouds that have built on the horizon,” Mr Front said. “Our investment policy and results are not going to depend upon whether we make a correct market timing decision. It’s about the item selection and about whether they fare the storms that definitely will be coming well.”

When the spread between two and 10-year Treasury yields flipped 10 times since 1956, it preceded recessions. But never right away