Back in March, JPM’s head quant Marko Kolanovic laid out the simplest case why despite all his bluster, angry tweets and constant puffing, Trump will not dare to engage in a full-blown global trade war which would impair the global economy and cripple capital markets. The reason: a plunge in the S&P would adversely affect the mid-term elections, potentially resulting in a big loss for the GOP and raising the threat of impeachment for Trump, should Republicans lose control of Congress. In Kolanovic’s own words:
A significant trade war started by this administration would destabilize global equity markets. Should this happen ahead of the November election, it would impair the administration’s ‘market scorecard’ and likely lead to an election loss. Lost elections open a path to impeachment, and other complications. The game is also non-zero sum, as one can both use tough rhetoric and at the same time do little disruptive action (e.g., players as we defined them can ‘have their cake and eat it’). Setting up a diagram (similar to the well-known ‘prisoners’ dilemma’) points clearly that there will be strong rhetoric, but weak or no action that would destabilize equities.
Then, over the weekend, Goldman took the opposite approach, inverting cause with effect, and stating that if Trump wants to win a trade war, the market has to tumble. By implication, if Trump is not willing to take said trade war to its bitter, market-adverse end, any Trumping threat will remain merely a negotiating tactic, one which America’s trade war adversaries will take increasingly less seriously, which is precisely why there is a risk that Trump may crash the market, just to prove to US trade partners that he is serious.
The question is will Trump dare to go that far.
The answer, according to DataTrek’s Nick Colas and increasingly, the market – is no… and is also one of the main reasons why US stocks remain resilient in the face of escalating trade tensions.
In his latest note to clients, Colas lays out 4 specific explanations why equities remain resilient in the face of escalating trade tensions, and at the very top, just as Kolanovic said, is that the market believes there is an implicit “Trade policy put” given the president’s well-known affinity for rising equity prices.
Other possible causes: continued strength in Tech shares, lower interest rates, and the relative strength of the US economy (and therefore stocks) versus the Eurozone and export-driven Asian countries.
Below we represent an excerpt from Colas’ always informative and entertaining daily letter, giving 4 reasons why Trade Wars have so far been…. Meh, for the stock market.
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The seemingly non-existent reaction of US stocks to mounting concerns of a global trade war remind me of an old Sherlock Holmes story, “The Adventure of the Silver Blaze”. That’s the one with the famous “Dog that did not bark” clue. A racehorse is stolen, his trainer murdered, all while a guard dog fails to raise an alarm. The reason: the dog knew the culprit (who was not the prime suspect) and therefore remained quiet.
Whether legions of equity investors have a collective IQ that exceeds your typical canine is an interesting question, but too large in scope for these pages. We will therefore focus our attention on some reasons why stocks seem impervious to the “Smoot Hawley, Part 2” narrative. Here are 4 potential explanations:
#1) President Trump is driving this process, and markets believe there is no way he consciously tanks the US equity market/economy ahead of midterm elections. Moreover, he is bucking both conventional economic wisdom and most of the Republican Party with his trade stance, leaving him fully exposed to any economic/market blowback.
Conclusion: almost like the concept of a “Fed put”, there is an implicit “trade policy put” on current rhetoric, no matter how harsh. If all the jawboning starts to hurt US business/consumer confidence or equity prices, markets expect President Trump to back away in the proverbial “New York minute”.
#2) Growth in US large cap Technology is powerful enough to swamp even trade fears. The S&P 500 is down 0.5% this year once you exclude the Technology sector (+11.2% YTD, and 25% of the S&P). This group moves to its own beat, and that tempo remains strong. All this comes even as Tech is the single most international group in the index in terms of offshore revenues (48%).
Conclusion: Large Cap Tech is in a bubble, but not necessarily in terms of valuation. Rather, it is an insulating force field driven by its power to create innovative disruption and growth. Those fundamentals are now at such critical mass that even governments cannot derail them for long.
#3) The uncertainty created by potential trade wars has been enough to halt the move to higher US interest rates, supporting equity valuations. Remember when the 10-year US Treasury seemed headed right to a 3.25% yield? That was all of 2 weeks ago. Now, problems in the Eurozone combined with trade policy concerns have pulled that yield solidly below 3%.
Conclusion: sometimes you get a Goldilocks outcome only after you’ve eaten way too much porridge and need to take a nap. Such is the case with the trade concerns we’re talking about here. The headlines that have dampened yields aren’t what anyone would call positive for global growth or stability. But they have had the effect of stopping the selloff in US bonds, and that supports equity prices.
#4) The economic effect of a global trade war may be worse on Europe, Japan and China than they are on the US, and global equity investors have to put their money somewhere. The recent troubles around the Italian election highlighted the still-fragile nature of the economic recovery in the Eurozone. Japanese Central Bank policy, easy as it is, has still failed to generate inflation. And China still needs US consumers to fund its expansion and continue to pull millions of its citizens out of poverty.
Conclusion: assume we do get a full out global trade war but your investment mandate still forces you to choose between US, Japanese, European or Asian equities. Where would you go? To the export driven markets? (No.) To the regional economy still struggling with the aftermath of the Financial Crisis? (Also No.) Or to the economy running close to capacity with 2 more quarters of tax-cut fueled growth? (Yes, if reluctantly so…)
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Summing up: US equities are threading a very fine needle with their current resilience. There’s just enough positive news (lower rates, Tech sector strength) to offset the headwinds of trade war worries. Friday’s jobs report buys some time as well, as it reinforces market confidence in the domestic economy. In the end, however, we think the “trade policy put” argument is the best explanation for recent US equity price action.
That may be an unexpected conclusion, but to quote Sherlock Holmes, “When you have eliminated the impossible, whatever remains, however improbably, must be the truth.”
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