For market investors, 'Trump trade' takes on a whole new meaning

8th March 2018

As Donald Trump himself has often pointed out, equity investors have found plenty to like in the president's mix of tax cuts and de-regulation (reports The Financial Times).

Now, a month on from the US stock market's correction, potential buyers of the recent weakness are having to rapidly calibrate the scale of the threat to economic growth and corporate profits posed by an escalation in global trade protectionism.

Less than 24 hours after Gary Cohn, the former Goldman Sachs executive and opponent of the tariffs planned by the White House, announced his plan to quit as Mr Trump's top economic adviser, the EU floated proposed duties on a range of US goods that could include Harley-Davidson motorcycles, Levi jeans and bourbon.

While rising trade tensions have soured the broad backdrop, the reaction so far has been modest. The Canadian dollar and Mexico peso — currencies exposed to the potential collapse of the North American Free Trade Agreement — have weakened, as have the shares of major exporters such as Boeing and Caterpillar.

Global car makers and steel producers have also been sold by rattled investors.

The risk to corporate profits from a series of retaliatory tariffs imposed by the world's biggest economic powers is hard to estimate, but analysts say a weaker global economy, accompanied by more inflationary pressures, may well extend the correction that shook markets at the start of February.

"The important issue is whether or not Cohn's departure will mark a radical shift in US trade and economic policies," said Stephen Gallo, European head of foreign exchange strategy at the Bank of Montreal. "If it does, it could have massive implications for global growth."

The challenge for money managers comes at a pivotal moment as markets try to find a firmer footing after a rapid 10 per cent drop on Wall Street rattled global stocks, bond yields creep higher and Jay Powell, the untested Federal Reserve chair, signals he would be willing to raise rates faster if the US economy overheats.

Now investors are once again having to navigate a tricky political backdrop.

"It's hard for markets to price in politics. How does one price in short tweets in the context of extremely complicated trade disputes?" asks Andrew Milligan, head of global strategy at Aberdeen Standard Investments. "It's a long way from saying large swaths of the stock market are going to be affected by trade wars but, with rhetoric about tariffs ratcheting up, a pattern appears to be emerging."

During the bull run, those sectors which traditionally fare well during periods of economic expansion have led the rally. Investors will be on guard for signs of sustained pressure on technology, consumer discretionary and financial stocks and a move back into more defensive sectors, like healthcare, utilities and telecoms.

How the dollar reacts to any outbreak of protectionist policies will be pivotal.

The index tracking the world's reserve currency is already down almost 14 per cent since its peak in January 2017 — touched just weeks ahead of Mr Trump's inauguration. Any further weakness in the currency in response to protectionist policies is likely to be most keenly felt by the euro and the yen, potentially hurting growth prospects for the eurozone and Japan.

The euro has risen sharply against the dollar — by around 20 per cent since the start of 2017 — so far drawing little response from a European Central Bank enjoying a recovery in the eurozone economy.

The ECB's governing council meets on Thursday, when investors will be watching for signs that policymakers are prepared to wrap up their bond-buying programme — and then raise interest rates — quicker than currently expected. Mario Draghi, the president of the ECB, is likely to be questioned on the potential threat from tariffs.

Nor will the ECB be the only central bank closely scrutinising the politics of trade.

"The Fed will be very wary of what is developing on the trade side," says Derek Halpenny, European head of global markets research at MUFG, the Japanese bank. "There are already emerging signs that the US economy is slowing. If we are entering a period of financial market volatility, the US economic outlook could deteriorate quickly."

Much now rests on Mr Trump's next steps and how he responds to threats of retaliation from major trading partners.

"We will breathe a little easier if his next act is again targeted towards a narrow set of industries," notes Paul Shea, economist at Miller Tabak + Co. "We will worry if they are broader, especially if directed against China. Gary Cohn's resignation is a worrisome sign that events could rapidly escalate."

Wall Street will be watching but it could ultimately prompt a more measured response from Mr Trump. If the mood among investors sours, he could be left politically vulnerable to a far deeper drop in share prices and the need to try and stem the damage.

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