US president Donald Trump rants against allegedly ‘unfair’ currency manipulators and ‘disastrous’ trade deals. British voters decided membership in the single market wasn’t worthwhile if it meant being subject to Brussels’ oversight.
Dutch politicians rail about protecting the nation’s economic ‘crown jewels’. France’s presidential election came down to a choice between a globalisation fan and a foe.
Multinational organisations warn near-daily that the current global economic expansion is at risk if this talk morphs into protectionist policy.
With this backdrop, it is unsurprising that a trade war is arguably the most widely held fear globally. Our private clients ask about it often. So does our bevy of institutional clients. It’s in the papers nearly daily.
Economically, they are right to ask: if protectionist talk led to the sudden introduction of trade barriers and tariffs, it could be quite bad. It might disrupt the global supply chain, vastly increasing costs for businesses and consumers alike. But from a financial market perspective, all this chatter likely means these fears are already weighing on stock prices. If they prove overstated – as we expect them to – stocks should spring higher.
Markets move most on the gap between sentiment and eventual reality. In March 2009, virtually all economic data were bad. Investors universally agreed the world was headed for a new depression; maybe worse.
Financial luminaries were sure a bull market couldn’t start whilst the world was contracting. In America, many investors worried the then-new Obama administration would champion nationalising banks.
Whilst reality was recession, sentiment feared far worse. When economic data showed things weren’t as bad as feared, stocks skyrocketed. Political fears that didn’t come true supercharged markets.
This relationship is why most bull markets are born in pessimism, and it applies to virtually all aspects of investing. Knowing reality is only part of the puzzle in divining market direction.
Right now fears over a trade war are depressing sentiment. You can see that in Mexican markets’ reaction to Trump’s win in November. On the campaign trail, Trump often painted Mexico as ‘stealing American jobs’ and claimed he’d revise or rip up the North American Free-Trade Agreement (NAFTA).
Roughly 81 per cent of Mexican exports by value went to the US last year, so protectionism affecting this relationship could severely impact Mexico’s economy.1 The peso and MSCI Mexico fell sharply after his 8 November win and remained weak until mid-January. Markets were pricing in an extremely negative brand of Trump trade war.
But since his inauguration on 20 January, Trump’s trade talk hasn’t become protectionist trade policy. Whilst he promised to label China a currency manipulator on ‘Day 1,’ a prelude to tariffs, he spent most of his first 100 days backtracking, before telling the world in April he’d do no such thing.
Trump made similar remarks about Japan before taking office, only to discard them over dinner with prime minister Shinzo Abe as the two discussed a trade deal. Regarding NAFTA, Trump’s administration has mostly announced they’d seek minor tweaks – not a repudiation. Unsurprisingly, the peso and Mexican stocks have rebounded sharply. Now, as we type, the peso is above pre-election levels. His only actions on trade are a couple of executive orders demanding agencies study extant deals, a tiny tariff decades in the making on Canadian lumber, and removing the US from the Trans-Pacific Partnership - an unratified deal unlikely to come into effect. Sour sentiment overshot reality.
Though France did put anti-EU and anti-globalisation presidential candidate Marine Le Pen into the decisive second round vote, she didn’t win.
Whilst Brexit talks are just beginning, it is worth remembering that UK prime minister Theresa May said she aims for a very comprehensive deal with the EU. And, though many feared the EU would object, in late April many ministers noted they wouldn’t refuse to discuss a trade deal alongside a broader exit agreement.
It’s all talk, but not overtly protectionist. Fear of a trade war is, at this juncture, just fear. That primes markets for positive surprise.
This is how the capital markets pricing mechanism works. If there is a widely held concern, it is likely already affecting investors’ willingness to bid stocks up. Fear gets baked into prices. If reality doesn’t match that – for good or ill – stock markets will rapidly adapt to new information.
For a big fear like a global trade war, that is likely to be a long process of stocks rising as fears gradually prove faulty. Don’t wait for Donald Trump to morph into Adam Smith – the time to own stocks is when fears remain to be dispelled.
1. Source: FactSet, as of 28/4/2017.
Ken Fisher is founder and chairman of Fisher Investments