US/China Trade Conflict Creates Factor Opportunities

In my discussions with clients from around the globe the past few months, I have been presenting the view that the US/China trade conflict will be a long, hard-fought battle that will likely play out over years, not months — and I still believe that despite the nations’ recent agreement made at the G-20 meeting. If the trade dispute indeed persists, the disruption is likely to weigh on economic growth rates, and equity markets are likely to continue to exhibit higher-than-average levels of volatility. In this scenario, I believe the Low Volatility and Quality equity factors may be especially attractive.

The trade war seems built to last

My position on the trade conflict stems from the US government’s evolving realization that China has become a technologically advanced, powerful and ambitious competitor. I witnessed this view at a dinner I attended in August where the featured speakers included three long-tenured US ambassadors, former White House foreign policy advisors, and two 25-year veterans of the CIA.

The speakers were invited primarily to discuss current geopolitics in the Middle East and the associated risks to the global supply of energy. The discussion was lively and punctuated by several debates regarding the preferred policy course in the Middle East. But while China was nowhere on the official agenda, the topic of the country’s rising competitiveness permeated the discussion with little debate — only agreement. In fact, one panelist deemed China to be the number one long-term economic and geopolitical competitor to the United States. That night, it became clear to me that the current conflict with China over trade practices is not for show, but is a response to a dramatically changing world. Therefore, I believe it is very unlikely that the US will “cut a deal” or lower trade tensions without meaningful concessions from China.

How likely are such concessions? When I was in Shanghai a few weeks ago, I took the opportunity to ask as many local investment professionals as possible their views on the course Chinese leadership would take in response to US trade-related demands. When it comes to a quick solution, there were no optimists.

That said, US President Donald Trump and Chinese President Xi Jinping made headlines during the G-20 meeting last week as they agreed to a moratorium on tariff increases. But while the deal avoids any immediate escalation of further tariffs, it does so for only three months, and the big issues between the two countries still remain. Additionally, this three-month delay extends the current uncertainty, which may continue to hinder business investment until there’s more clarity about the ultimate outcome.

What does this mean for investors?

First, if the trade dispute between the US and China (and other trading partners for that matter) persists, the disruption is likely to weigh on economic growth rates as tariffs reduce trade and corporate managers pull back on capital investment (which typically suffers when regulatory uncertainty clouds business managers’ ability to forecast returns on those investments). The slowing economic growth —and the stronger dollar that has emerged since the trade conflict began nine months ago — have already begun to push down inflation in the US and may have brought the US Federal Reserve closer to a pause in its current rate-hike cycle.

Second, both US and international equity markets are likely to continue to exhibit higher-than-average levels of volatility. Cool trade relations may cause companies to adjust and redirect their supply chains and rethink investment plans, while putting Chinese and US growth in question. The cold war in trade has the potential to impair corporate profit growth and make investors uneasy.

Which factors could potentially help in this environment?

From a factor perspective, Low Volatility and Quality, both domestically and internationally, may provide avenues for navigating trade tensions.

  • Low Volatility stocks may provide upside potential while helping to cushion the impact of market declines. Risk mitigation may prove attractive as the trade battle plays out, and upside participation can provide a benefit given any signs of reconciliation and settlement (such as the stock market rally after the G-20 meeting). Low Volatility also tends thrive in environments of rising or elevated volatility as well as high correlation, which can be present during periods of market stress.
  • The Quality factor provides access to companies that possess high return on equity, low leverage, and the ability to generate cash earnings. Quality companies may be in a stronger position to weather the disruption or transition in global supply chains and associated economic stress relative to lower-quality companies.

Invesco offers Low Volatility and Quality strategies that are dynamic in their sector allocations (and, for international strategies, their country allocations). By seeking out stocks with the lowest volatility and highest quality in their respective universes, these strategies present an opportunity for investors to reduce exposure to areas where trade war risks are most magnified.

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Important information

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Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes that may explain differences in returns. There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain factors. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. Factor investing may underperform cap-weighted benchmarks and increase portfolio risk.

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Funds’ return may not match the return of the Underlying Index. The Funds are subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the Funds.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Investments focused in a particular industry or sector are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

There is no assurance of low volatility.

Correlation is the degree to which two investments have historically moved in relation to each other.

Jason Bloom
Director, Global Macro ETF Strategy

Jason Bloom is the Director of Global Macro ETF Strategy for Invesco’s family of exchange-traded funds (ETFs). In his role, Mr. Bloom is responsible for providing a macro market outlook across all asset classes globally, in addition to leading the team’s specialized efforts in fixed income, commodity, currency, and alternatives research and strategy. He joined Invesco in 2015.

Prior to joining Invesco, Mr. Bloom served as an ETF strategist for six years with Guggenheim Investments and then River Oak ETF Solutions, where he helped launch several funds focused on both energy and volatility-related strategies. Previously, he spent eight years as a professional commodities trader specializing in arbitrage strategies in both the energy and US Treasury markets.

Mr. Bloom earned a BA degree in economics from Gustavus Adolphus College and a JD from the University of Iowa College of Law. He holds the Series 7, 24 and 63 registrations.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

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