Trade War pause boosts risk assets

Investors who were desperate for positive news finally got some at the end of last week. After an ongoing US-China trade war that has lasted 18 months and rattled financial markets, the White House administration announced on Friday that the two sides had agreed on phase one of a trade deal. The EU is undergoing substantial negotiations with the Brits to resolve the Brexit dilemma, which saw Sterling jump five figures in two days. On the monetary side, the Fed addressed the issue of short-term lending by extending its temporary repo operation and decided to buy more short-term Treasury bills.

The positive developments over the end of last week boosted equity markets with the S&P 500 closing 1.1% higher on Friday to end three consecutive weeks of declines. More importantly, the US Treasury yield curve steepened dramatically, with the 10 Year – 3 Month Treasury yield spread moving back into positive territory for the first time since late May.

While such optimism may lend risk assets further support over the coming days, it is still too early to conclude that a new bull run will occur. What we do know so far is that the US has agreed to stop a planned increase for this Tuesday of an additional 5% in tariffs on $250 billion of Chinese goods. Meanwhile, China agreed to buy $40 to $50 billion of US agricultural products and committed to open its markets to US financial services.

The "Phase I" deal did not really address the most sensitive issues in the trade dispute, especially technology transfer, intellectual property theft and currency manipulation. The deal also didn't remove any of the existing tariffs on Chinese imports. If you're a US or a Chinese business, such developments will not help deciding on your future plans. That's why I like to call the current agreement a trade truce rather than a trade deal.

President Trump may want a more robust deal heading into the election season and given the ongoing impeachment inquiry. However, nothing guarantees that talks don't breakdown again like we saw in May.

Back to fundamentals

While we continue to see a lot of background noise related to trade and geopolitical issues, investors will need to focus back on fundamentals.

US banks unofficially kick off the Q3 earnings season on Tuesday. According to Factset, financials are likely to see revenues drop given the negative impact from lower interest margins. Overall, earnings are expected to decline 4.1% for the S&P 500 companies following a 0.4% drop in the second quarter.

Looking at where the S&P 500 index stands right now, it doesn't reflect such pessimism. Falling interest rates and hopes of a trade deal have pushed stocks up near record highs. However, we need strong positive earnings surprises for stocks to hold near these levels.