Disappointed With Phase One Trade Deal? Wall Street Sees Something It’s Looking For

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The phase one trade deal, on its face, isn’t incredibly material to economic growth, but it potentially indicates the White House and China are moving towards a comprehensive agreement. One of Wall Street’s biggest banks now recommends holding an overweight position in the equity market from neutral.

Last week, the U.S. and China agreed to cancel tariffs previously scheduled to go into effect December 15. Plus, existing tariffs on Chinese goods moving into the U.S. will be rolled back to 7.5%. The canceled tariffs were on goods only worth a total of $160 billion, which only represents about 0.7% of a U.S. economy that economists predict will produce $21.35 trillion worth of goods and services in all of 2019. 

Wall Street has been searching for indications not only that the two largest economies in the world would come to a phase one agreement, but that a comprehensive agreement is is in the cards.

And  (UBS) - Get UBS Group AG Report is encouraged. 

"We think it is significant that the announcement represents the first time that trade negotiations have led to an actual reduction in tariffs, rather than a mere delay," wrote UBS' Chief Investment Officer of Global Wealth Management, Mark Haefele. "We may have reached the point of “peak tariffs” and this deal could be the start of a series of phased roll-backs." 

The S&P 500 at first had a muted reaction to the news, but is now up 09.% in just the two days after the agreement. The index is up roughly 10% since October 8, when investors became particularly optimistic there would be a trade deal. The deal, combined with better-than-expected third quarter GDP has dramatically reduced the likelihood of further interest rate cuts in the near future and the Fed has responded in kind. Much of the 26% gain for the S&P 500 has been on the back of monetary stimulus, with the 10 year treasury trading at 1.88%, lower than the 2.67% it was at to start 2019. 

Now, Wall Street is expecting business investment to tick up on the back of better certainty. Large-cap U.S. companies across several cyclical sectors had been hesitant to invest for the long-term, as uncertainty over the direction of trade clouded the demand picture for goods and services. This posed a threat down the road to hiring and therefore the currently strong consumer. UBS mentioned it's now expecting stronger business confidence and investment. "This could unlock further upside for equity markets," UBS said. 

And although the 10 year treasury yield has ticked up slightly, UBS still likes stock valuations compared to treasuries. Currently, the avergae stock on the S&P 500 trades at just below 18 times next year's earnings, which some call fairly valued, others slightly overvalued. The current equity risk premium -- the difference in expected one-year return in stocks versus that of safer treasuries-- is 3.7%, a historically descent spread. If earnings estimates are revised upward in the near future, that risk premium could expand even more. 

Wall Street had been calling for about 5% gains on the S&P 500 for the next year before the phase one deal -- key to unlocking higher earnings growth -- was announced. 

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