A trade war brought on by U.S. protectionist policy may not exactly be a “black swan” event that we believe is needed to end the bull market in risk assets, but the potential disruptions to the global economy should not be minimized. Nor should the implications for profit-taking in risk assets, priced for perfection after the U.S. corporate tax cuts.
So far, foreign steel and aluminum imports into the U.S. will be targeted by the Executive Order that Trump is expected to sign this week. However Trump also hinted that his crack down on trade could run even deeper, citing China’s alleged theft of intellectual property. The U.S. is said to be considering clamping down on Chinese investment and imposing tariffs on a broad range of goods to punish Beijing over unfair IP practices.
President Trump has said, “Let’s have a trade war; they’re easy to win”. And he appears to be convinced that tariffs will make America great again. For Trump, the “facts” are on his side. The U.S. trade deficit widened to a post-recession high in January of $56.6 billion as exports declined. The message out of the White House is unambiguous – the U.S. is freest trader in the world and all the U.S. gets for that is a half a trillion dollar a year trade deficit that off-shores American wealth and jobs.
We believe that Trump, surfing the wave of populism, will indeed continue with economically unsound measures that please his electorate: broad tax cuts, deregulating banks, deficit spending, and now trade tariffs. Gary Cohn, his chief economic advisor, disagreed with trade tariffs and resigned. Paul Ryan, the leader of his party in control of Congress, attempted to dissuade the president and is repudiated. The response of the world’s leaders is ignored.
This president is going to start a trade war. So, what is the cost of a full-out trade war of the kind Gary Cohn must fear in order to have caused his resignation?
Unless this mindless stupidity is stopped, somehow, the ultimate cost will be millions of human lives because trade war taken to the extent Trump says is needed will at some point lead to military war, likely fought over oil and gas in the Middle East. But, let’s walk before running to discuss the most likely chain of events.
Trade war will impact corporate ability to transact business in the normal course. Revenues will fall, costs will rise, and earnings and dividends fall. For certain, corporate valuations will decline, which will cause equity market valuations to fall.
In response, in order to sustain profitability, corporations will cut costs by laying off workers, which will cause consumer spending to drop. Then corporations will raise prices to try to hold the line on revenue.
Higher prices will lead to greater inflation. As the economy winds down and inflation increase, the market narrative will change to stagflation.
Without the needed contribution from the corporate and consumer segments, the economy will go into recession. Corporations will reduce capital expenditures and reduce or withhold dividends. With less income and greater costs, the public will become desperate. Goods will be hoarded. Petty crime will increase. The inflows of retired people will drop, causing failure in their ability to pay bills, leading them into the same desperate situation as the unemployed.
As society breaks down, government will increase expenditures. But that contribution will be insufficient to stop a major recession. To protect their control over the financial system, banks will seize assets and raise rates. Real estate prices will drop. Shopping malls and residential communities will close and become boarded up.
But the president will not renege on his intention to have his trade war. So, his grand infrastructure plan will be implemented at unaffordable cost. People will be employed; but cost in terms of inflation will exceed any short-term benefit.
The president then will turn to a military war as the only way out to increase production of goods and services and lift employment as millions of local workers are needed to replace those soldiers being sent abroad in some misguided program to “Make America Great Again”. But in the next war, Weapons of Mass Destruction will be deployed and used. In addition to massive loss of life, there will be a massive wave of inflation that will destroy the value of money.
Crypto-currencies will be banned by the authorities but continue to be used by the public in open confrontation. Precious metal prices will soar with prices reaching levels long called for by the promoters of the gold industry.
At the end of the day, the next war will totally change life as we know it. This president will be the cause.
The process as described, once begun, is inevitable. The only question is, does Congress have the will to override the power of the presidency.
Near-Term Market Outlook
The latest news of the White House is that Trump with be conciliatory in applying flexible, “equitable” tariffs (whatever that means). Markets ended up rallying this week despite talk of trade war….much as markets rallied when we heard talk of a war with North Korea.
Equity markets remain capped on the downside by the perception of a strong economy and capped on the upside by equity valuations. The growth/technology stocks continue to be the market leaders while resources stocks are still the market laggards. We believe the roles of these two sectors should be reversed, as higher inflation/commodity prices should pull the latter higher and rich valuation push the former down.
To conclude, we take a big picture perspective of these two sectors. The top chart is the Nasdaq-100 (QQQ) and the bottom chart is the S&P North America Natural Resource Index (IGE). If price is a good indication, technology stocks are the most crowded (over-owned) in history while resource stock are likely under-owned at this stage of the equity cycle. Our Natural Resources fund is a bet that resource companies will soon benefit from outflows from technology stocks.
