Hello, I hope you had a wonderful Easter break and welcome to this month’s equity market review with me, Ritu Vohora.
Volatility is back. Following its worst weekly performance since January 2016, the S&P 500 saw its biggest one-day gain since August 2015. The index has moved by more than 1% in either direction on 21 days since the end of January - the SAME number of occasions as in the entire 18 months prior!
As risk aversion set in again, safe-haven government bonds led performance in March. Global equities retreated on trade war concerns and negative news flow from tech stocks in the wake of Facebook user privacy concerns. Japan and the US underperformed the most, whilst Europe and Emerging markets outperformed the global index.
A flight to safety saw defensive sectors such as utilities outperform, while cyclical areas including financials and materials lagged. Style performance was mixed across regions, however, high beta and momentum largely lagged.
As we look ahead to the second quarter, stock markets are faced with renewed choppiness – concerns about rising bond yields have now shifted to the potential for corporate profits to be undermined if a trade war erupts.
Over the Easter weekend, China announced a new round of tariffs of up to 25% on US products, including pork, fruit, nuts and wine. The announcement was a direct response to the US tariffs on aluminum and steel. This was a targeted response - many of the 128 products on the list originate from states that favoured Trump in the 20-16 presidential election. Since then, China has proposed it would levy an additional 25 percent on around $50 billion of US goods including soybeans, automobiles, chemicals and aircraft – a tit-for-tat response to proposed American duties on its high-tech goods. This raises concerns that what began as a ‘trade spat’, could turn into a more harmful ‘trade war’. China is still balanced in its response and the implementation date of its reciprocal tariffs depends on the outcome of bilateral negotiations and US decisions.
US protectionism is based on Trump’s desire to protect specific US industries, reduce the trade deficit and broader political motives, with the US mid-terms in November.
Moderate tightening of trade and investment rules would likely only have modest macro consequences. However, an escalation into a full-blown global trade war, would have significant negative effects on the global economy. The effects of protectionism are uncertain, but the OECD estimates that a permanent 10% rise in trade costs can lower global GDP by roughly 1-1.5% in the medium-term. Adverse effects are reinforced by a decline in global activity, a retaliation by other countries, rising uncertainty dampening business confidence - resulting in a reduction in capital and R&D expenditure and trade frictions leading to broader international tensions.
Protectionism has historically also boosted inflation, which could make policy setting by the Federal Reserve more difficult, and lead to ongoing bouts of market weakness and heightened volatility.
If history is any guide, no one wins in a trade war. At this point, initial market reaction is swayed by tough rhetoric. But is Trump’s bark worse than his bite? Tough talk has been a precursor to negotiation, suggesting the trade spat does not necessarily deteriorate into a trade war. Major trade partners, Canada and Mexico are both exempted from the steel and aluminum tariffs, and temporary exemptions have been granted to the EU, Argentina, Australia, Brazil and South Korea, with the door left open for talks. China has more to lose from a trade war, but the US needs to tread carefully - after all China, it’s biggest creditor, could also scale back purchases of Treasuries in retaliation. Trump may have a protectionist inclination on trade, but he is also pro-business and uses the S&P 500 as a barometer of success. A trade war, threatening a large decline in the stock market and US jobs, is not in his interest, or that of his support base.
The global ‘Wall of Worry' has a few more bricks in it, with plenty of risks emerging to shake investor confidence. But, ironically, this is probably a healthier investing environment - which could help keep the bull market alive. Complacency over the growth outlook appears to be correcting, but the global economy still looks healthy. Valuations, were stretched as we entered 2018, but have retreated somewhat—courtesy of both the correction in prices, but also earnings strength.
Trade protectionism remains a threat to global growth, but a positive earnings tailwind should help markets continue to climb the wall of worry.
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That’s it from me and see you next time.