Tactical Asset Allocator: Will trade wars end the eight-year bull market?

The markets are taking fright at the prospect of a trade war as president Donald Trump prepares to introduce tariffs on aluminium and steel imports, forcing Beijing’s foreign minister Wang Yi to announce that China will respond in kind.

Trump’s tariffs could damage the US economy across the board. The stock prices of heavy users of these industrial metals – the likes of Boeing and Ford Motor – have tumbled, but higher steel prices, which rose 20 per cent in anticipation of the tariffs months ago, have also been pulling down the machinery, motor vehicle and construction industries. The exit of Gary Cohn, Trump’s respected economic adviser, who opposed the tariffs, now leaves policy at the White House to be shaped by nationalist advisers.

Ironically, the tariffs will incentivise manufacturers to move production off shore. The suggestion that there may be concessions for Mexico and Canada ahead of further North American Free Trade Agreement (Nafta) talks highlights the president’s skulduggery – his primary aim after all may be to negotiate more advantageous trade deals for the US. There is less doubt about Trump’s intentions regarding what he sees as Beijing’s theft of US intellectual property. US companies are frequently forced to transfer their IP to China as a price of doing business there. However, 45 major trade associations have urged the administration to back down from plans to levy charges on Chinese IT, telecoms and consumer goods, in an attempt to force changes in Chinese business practices. Although the 1974 trade law that authorised the original investigation allows retaliatory tariffs to be imposed, the groups’ letter says this would provoke retaliation, stifling exports and raising costs for businesses and consumers.

Small wonder that we have seen a sharp upswing in volatility that is very different from the US wages rumpus in February, when markets quickly settled back into a narrow trading range. If we look back at that US wages growth data again, it looks pretty unremarkable. It could surely have been no surprise that US wages had been rising at their fastest annual pace since 2008. However, the data reinforced the US Federal Reserve’s outlook for three interest rate hikes this year, starting as soon as March, and also flagged up the possibility of a fourth increase in 2018. New Federal Reserve chair Jerome Powell reinforced this with a hawkish tone at his first appearance in front of Congress.

Yet rate rises from the current low base are still months away from materially affecting the US economy, which is still the strongest among the major developed nations, and is set to enjoy considerable corporate and income tax cuts.

-The BRICS: Which country should investors back for big returns?

US equity valuations are eye-watering and at a significant premium to others, but many investment experts believe they are justified by their potential for strong earnings growth, and even triple-figure tech stock valuations may be a profitable way of accessing the digital internet revolution. Some investment banks such as UBS have been purchasing out-of-the-money put options on the S&P 500 to profit from further market falls, but importantly these have been limited to small slices of their portfolios.

One thing the recent mini-crash made clear, however, is that so-called quant trading unravels very rapidly. It’s been estimated that only 10 per cent of equity trading volume is now driven by human decision-making. High-frequency trading run by algorithms that buy and sell stock in microseconds accounts for the lion’s share. If these highly leveraged computer programs simultaneously sell, the market could plummet faster than anything seen to date.

Brexit doubts

Meanwhile, the UK’s position has been damaged by some dismal trading results and the significant FTSE 100 mining sector has been hurt by falling Chinese demand for industrial metals such as copper and zinc.

The Labour Party, having previously aligned itself with government strategy on Brexit, has shifted its position to cause maximum damage to Theresa May. Such strife is not a good message for foreign investors, and the prime minister – dubbed ‘Auntie May’ by the Chinese press – received a muted welcome on her first official visit to China to meet Xi Jinping.

London-listed stocks have underperformed most major world markets over the past 18 months. The FTSE 100 gained 10 per cent in 2017, less than half the rise in the US and Asian markets. The time might therefore seem ripe for a counter-cyclical punt, but other growing economies come without such political risk, and already UK GDP has been revised downwards to 0.4 per cent quarter on quarter. With growth of just 1.5 per cent predicted for 2018, the UK lags even Italy and Japan as Brexit uncertainties grind down business.

Across the rest of Europe, the consumer prices index fell back to 1.2 per cent, a 14-month low, suggesting that ECB president Mario Draghi was correct to play down the prospect of inflation and facilitating monetary easing for some time to come. His political tight ropewalking skills have enabled him to emphasise more dovish elements of the bank’s monetary policy in his recent statement and drive down the euro, which in turn helped lift stocks. That follows recent weeks when the euro climbed and European stock markets tumbled, plagued by fears that the ECB would raise rates quickly. 

It may be tempting to eschew cyclical shares and lean toward a more defensive equity income strategy at this point. However, there are obvious opportunities in nascent markets such as those in Vietnam and Cambodia. These two nations have implemented reforms to make their respective economies market-driven, as their burgeoning tourism industries testify. Having been isolated from foreign investment and trade for decades, Vietnam’s well-educated young are turning Ho Chi Minh City into an Asian Silicon Valley, creating a vibrant tech entrepreneur scene.

We are therefore buying shares in the closed-ended Vina Capital Vietnam Opportunity fund (VOF.UK), one of the few pure plays on this economy. One of the fund’s attractions is its access to off -market private equity deals and the development of the nation’s consumption, construction, infrastructure and real estate markets. 

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