Well, it’s time for Goldman to go ahead an update the old (and now the “new”) “trading days without a 5% S&P correction” chart. As noted earlier this week, we broke a record on that score amid the best start to a calendar year since 1987. Here’s the updated version:
Relative to realized vol., we just witnessed the best start to a year since 1967. Happily for those trying to convince themselves they don’t have a gambling problem, the tax bill-related surge in earnings estimates means the forward multiples haven’t risen with stock prices.
Although a sudden uptick in inflation and the assumed hawkish policy response that would engender from central banks remains at the top of the worry list for investors, the prospect of a trade war grabbed headlines this week following Trump’s decision to slap tariffs on residential washing machines and solar equipment. Those fears intensified meaningfully starting on Wednesday when Steve Mnuchin decided it would be a good idea to jawbone the already beleaguered dollar lower upon touching down in Davos.
Of course none of that bodes well for the NAFTA talks or really, for trade negotiations in general. Here’s what we said on Thursday:
Mnuchin’s weak dollar comments came less than two days after Trump slapped tariffs on foreign washing machines and solar equipment. The timing is obviously not a coincidence. Taken together, this would appear to mean that the administration is getting serious about Trump’s campaign trail trade rhetoric – and at just the wrong time. NAFTA negotiations are ongoing and according to Reuters (out this morning), the U.S. “hasn’t moved an inch“. Rumors are circulating that China is considering whether they might be able to hit the U.S. where it hurts in retaliation for any aggressive trade measures by paring purchases of U.S. Treasurys at a time when supply is set to rise (think: the tax bill ballooning the deficit) and the Fed is winding down its balance sheet. Additionally, the dollar is already coming off its worst year since 2003 and is sitting at its lowest level since 2014.
So there’s that. With regard to NAFTA, trade, and the potential for trade war jitters to upend the rally, Goldman has some thoughts.
“The combination of trade risks has caused the Trade Policy Uncertainty Index to jump sharply in recent months, reaching the highest levels since last April but remaining far below post-election highs,” the bank writes, in a note out Friday evening, adding that “on Tuesday, President Trump will deliver his State of the Union address, which could potentially increase investor focus on risks to trade in general and NAFTA in particular.”
Long story short, Goldman thinks it’s likely that Trump announces his intention to pull out of NAFTA but doesn’t see that as a particularly acute risk for the U.S. economy – or at least not in and of itself. The bigger question is what it signals to China. Here’s Goldman:
From a macro perspective, withdrawal from NAFTA would likely pose a minor risk to overall US economic growth and corporate profits. US/Canada trade would likely be covered under a prior free trade agreement, and exports to Mexico account for just 1% of US GDP. Similarly, revenues to Mexico and Latin America total just 3% of S&P 500 sales. However, withdrawal could harm risk sentiment by raising the risk of intensifying global trade conflict. Our economists have discussed the growing risk of trade conflict specifically with China.
Trade conflict is a risk that extends beyond NAFTA; concerned investors should focus on US stocks with the most domestic exposure.
Again, the risk here is that this spirals out of control in terms of the administration’s ability to clearly and effectively communicate what it is they’re trying to accomplish beyond some nebulous platitudes about restoring lost American “greatness”.
As we saw this week, they’re not so good at being subtle.