Analysts Can Think Of Worse Things Than A Trade War – Like Say, ‘An Asteroid Hitting The Earth’

One of the themes I’ve been harping on over the past several days is the notion that because markets haven’t had sufficient time to recover psychologically from last month’s technical selloff, it’s probably not reasonable to expect everyone to demonstrate some kind of stoic fortitude in the face of seemingly hawkish Fed rhetoric and the threat of a global trade war.

Here’s how I described the setup in a post for Dealbreaker on Friday:

Headed into March, investors hoped the turmoil that unfolded in early February was largely a one-off event. To be sure, there was plenty of evidence to support that assessment. The VIX “Minksy moment” on February 5 was in no small part attributable to levered and inverse VIX ETPs, whose vega-to-buy (i.e. the rebalance risk inherent in the structure of those products) had reached historic highs in January. The black swan vol. event triggered a VaR shock and forced de-risking by systematic strats and the subsequent cascade effect culminated in February 5-9 being the worst week for U.S. equities in two years (it would have been the worst week since the aftermath of Lehman were it not for a late afternoon rally that Friday courtesy of a JPMorgan note that suggested the risk parity and CTA unwind was largely complete).

So the thinking was that with the deck cleared on the VIX ETP rebalance risk and with the systematic deleveraging out of the way, markets had the green light to calm down.

Needless to say, markets have not calmed down. In fact, 1% moves in either direction are starting to become more “norm” than “exception” and that’s thanks to the fact that folks have been forced to skip straight from worrying about market structure issues to worrying about a cornered Fed with a new leader and a seemingly unhinged President hell-bent on subjugating utilitarian ideals and the well-being of the global community to his overriding desire to check a box on his list of campaign promises.

 

This has the potential to come to a head next week as jitters about whether the tariffs could prove to be inflationary collide with the February jobs report. Simply put, if the average hourly earnings number in the payrolls data surprises to the upside like it did in the January report, all bets are off.

Just taking a second to kind of step back and assess this situation for the umpteenth time, it looks like a perfect storm. Trump is adding fiscal stimulus and deficit-funded tax cuts to an economy running at full employment and the increased Treasury supply that’s part and parcel of financing his foray into expansionary fiscal policy comes just as the Fed is trying to run down the balance sheet. Expansionary fiscal policy at this stage in the cycle is likely to be inflationary and the changing supply/demand balance in the Treasury market is almost guaranteed to put upward pressure on yields. There are already second-order effects for foreign Treasury demand from the increased bill supply and if Trump’s trade war further depresses foreign appetite for U.S. debt at a time when the rollback of stimulus in other DM economies makes their domestic bonds some semblance of attractive again, well then there’s no telling what the clearing price for the deluge of new supply is going to be.

Getting back to the tariffs, it would be difficult to overstate the extent to which this move has been universally derided by pretty much everyone who knows what they’re talking about. The bottom line is that the potential downstream job losses are virtually sure to outweigh any gains in the steel and aluminum industries and then there’s the squeeze on consumers (i.e. the inflation mentioned above) and the irreparable damage to America’s international reputation.

“Why would tariffs on these small sectors trigger such a strong [equity market] response?,” BofAML asks, in a new note. “In our view, the markets are worried about a slippery slope,” the bank continues, answering their own question before elaborating as follows:

New measures are being introduced at an accelerating pace [and] it also appears that protectionists are increasingly winning the policy debate: initially the Trump administration backed away from strong measures; for example, they choose not to declare China a currency manipulator; more recently they have been following through on a steady diet of protectionist measures.

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For their part, Barclays notes that “while direct effects of these remedial trade measures are likely to be limited, the real risk lies in the response of US trading partners and whether the administration’s decision is only the first in a series of moves.”

The bank goes further, warning that they “have long viewed the primary risk to the US and, indeed, global recovery, is an unleashing of anti-trade policies, which would do little to reorganize trade flows and, instead, would more likely act as a tax on consumers and business, slow economic activity, and increase uncertainty.”

Credit Suisse is a bit more sanguine, but their relatively benign outlook essentially rests on the assumption that Trump is bluffing. “We can’t be sure, but we doubt a full-blown trade war is likely,” the bank writes in a note dated Friday before adding that they “also tend to think that the US equity market response to these actions will have some impact on Trump’s thinking, particularly as mid-term elections approach.”

Yeah, that’s what we thought too. And then Friday turned into Saturday.

Goldman was out with a pretty expansive take late this week as well, and while there’s a lot to it, the quick takeaway is that while they “remain constructive on global equity markets and continue to be overweight on a 12-month horizon,” they make clear that “one potential risk” to that base case “is that global growth slows, or profits are hit, by increased US tariffs on trade and the possibility of an escalating global trade war.”

Right. And BNP is also out chiming in, noting that “with major corporations having developed business models and supply chains in an era of steady increases in global trade, it seems reasonable to expect some negative impact on the risk environment if global trade relations deteriorate markedly.”

And on, and on. You get the idea. This is a big (league) deal.

But as amusing as all of those takes on the issue are, easily the best soundbite comes from GMO’s Ben Inker who said this on Friday:

Yesterday’s announcement by President Trump of imminent tariffs on steel and aluminum imports was taken poorly by global stock markets. Perhaps in an attempt to convince investors this was an incorrect response, early this morning he tweeted that “trade wars are good, and easy to win.” He is wrong, and beyond the simple fact of his wrongness, a trade war is probably more dangerous for investors at this time than at any other time in recent history given the implications it would have for inflation, monetary policy, and economic growth. The only positive from the tariffs is that it is a windfall profit increase for U.S. producers of steel and aluminum, which is at least positive for them. It is unlikely to cause any material increase in U.S. capacity to produce steel and aluminum and therefore unlikely to lead to many additional jobs even in those sectors. The negatives are much more significant. I believe these tariffs on their own will push inflation higher, and higher inflation is a threat to the valuations of more or less all financial assets today. But the greater threat is that this escalates into an actual trade war. A trade war would increase prices on a much broader array of goods and services, while simultaneously depressing aggregate global demand. This pushes us in the direction of not just inflation but stagflation, where both valuations and corporate cash flow would be under pressure. While there are scenarios that would be worse for financial markets–the proverbial asteroid on a collision path with Earth comes to mind–a trade war has the potential to be very bad for both the global economy and investor portfolios. As I wrote about last December, a significant inflation problem might well be the worst thing that could happen to a balanced portfolio, leading to losses on the order of 40%. A global trade war would be exactly the kind of economic event that could foreseeably lead to losses of that magnitude.

So basically, Ben just said that the only thing he can think of off the top of his head that would be worse for financial markets than Trump starting a trade war would be if the plot of Seeking A Friend For The End Of The World became reality.

With that, we’ll simply leave you with the full note from GMO which you can peruse at your leisure…

 

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4 thoughts on “Analysts Can Think Of Worse Things Than A Trade War – Like Say, ‘An Asteroid Hitting The Earth’

  1. It could only be. ART OF THE DEAL opening gambit talk. Or….it could be a “neccessary” ploy to consolidate the voters for midterms this year. Let’s see: Big deficit, tightening FED, lower corporate taxes, on edge markets, North Korea, Italian elections, Kuroda, still Draghi….nobody solves all that so we clear at a 9 P.E.

    1. He’s so smart and so genius, how could we possibly figure out his 4-dimensional chess tactics of flipping the board over and scattering all the pieces?

  2. Last week Trump said he’d support a ban on assault weapons and he promised to impose uuuge tariffs on imported aluminum and steel. This is a major part of Trump’s media manipulation playbook, and is merely a warm up for the main act. Throwing the world into global economic chaos is great way to divert media attention from the Hicks split and J-Kush’s security clearance/influence pedaling scandal. In normal times the Trump Panama City Hotel would be the lead story on MSNBC. But these aren’t normal times.

    I predict that “Trump Tariff Crisis” will blow over in a week or two, and the S&P 500 will resume its march toward 3000.

    Trump is a crappy President, but he has a certain mastery of mass psychology. He clearly relishes crisis and controversy and shows no concern about ethics or the Truth. Trump can feel the Mueller noose slowly tightening around his fat neck. He knows that his goose will be cooked to a crisp in the not too distant future unless he can come up with a strategy to hold the hounds at bay.

    Given what we know about Trump’s skill set, and the current world dynamics, I see one extremely likely scenario. Think Putin, Iran and Syria, with a side order of Israel.

  3. Love Ben Inker: “Despite everything I have written above, we have not made…any material changes to our asset allocation portfolios.” Get an emotional support animal.

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