Last week, U.S. tariffs were announced on steel and aluminum imports—25% on steel and 10% on aluminum. Canada and Mexico are excepted, so long as NAFTA negotiations are ongoing.
The exception notwithstanding, the development isn’t good news for investors.
“Protectionist U.S. trade policies will do more harm than good, not just to the country’s export partners but the U.S. economy itself,” says an RBC monthly markets report. Noting equity market volatility and lower Treasury yields last week, the report says, “Markets are concerned this could be the first salvo in a larger trade war,” which would hamper synchronized global growth.
Further, protectionist measures could generate inflationary pressure, says the report. Slow growth with inflation “makes for a difficult tradeoff for central banks.”
In weekly global commentary, Richard Turnill, managing director and global chief investment strategist at BlackRock, puts market reaction in perspective, saying that “limited trade actions” likely won’t hurt risk-on sentiment or “shatter the low volatility market regime.”
Yet, he concedes that a potential escalation to trade wars is “arguably the most disruptive geopolitical risk to the global expansion and markets in 2018.”
In the BlackRock report, a graph shows market reaction from six major trade risk events since 2oo2. The results: gold and yen outperformed, while Chinese stocks, led by consumer durables and automakers, suffered the heaviest losses.
But no one can know how a particular trade war will shake out.
“We note that the different nature of each trade-related event could trigger different reactions—and that an actual trade war would have a much greater impact on a range of assets,” says Turnill.
Overall, market impact will depend on how U.S. trade partners respond to U.S. tariffs, he suggests.
For example, “The European Union (EU) has threatened retaliatory measures against a set of iconic U.S. goods,” says Turnill. “Trump in turn threatened further measures against European carmakers.”
Further, a global protectionist trend could emerge if the EU applies countermeasures to all its trading partners, he adds.
He expects China to “make serious efforts to avoid a trade war.” Over the medium term, “we see China addressing its trade deficit with the U.S. by opening up its market to more imports, rather than slowing exports.”
He also says a NAFTA withdrawal is unlikely, but, should it occur, “we could see Mexican and Canadian currencies plunging and global risk assets selling off,” he says.
For now, if trade action remains limited, sound market fundamentals won’t be affected, “with any volatility spikes around protectionist measures likely to be short-lived,” he says. “The robust global growth environment supports the low-volatility regime and risk assets.”
If protectionism starts to harm global growth, he’ll reassess his view. “We believe emerging market currencies and equities would be hit hardest, triggering a global flight to perceived safe havens such as government bonds and the yen,” he says.
Inflation would also increase, as global supply chains are disrupted and the cost of imports rises.
“This could increase the pace of the Federal Reserve’s monetary policy tightening,” says Turnill.
Over the next three months, Turnill’s overweight equities, including those from the U.S., Europe, Japan and emerging markets, and he’s underweight U.S. government bonds, European sovereigns and European credit.
Tips to manage loss aversion
With more volatility potentially on the way, now’s a good time to review behavioural biases.
For example, a Richardson GMP report reminds that loss aversion, which recognizes that investors feel more pain from losses than pleasure from gains, should be managed.
“Loss aversion can often lead investors to hold on to losing investments too long and sell their winners too early,” says the report, noting research that shows winners tend to keep winning and losers tend to keep losing.
Further, “If you add the tax drag of selling your winner [versus] the tax benefit of generating a capital loss, it makes even more sense to sell the loser and keep the winner,” says the report.
To avoid mistakes, the report suggests investors use dynamic stop-alerts, as opposed to live stop-loss orders.
“Stop-alerts are dynamic, in the sense they move with the overall market,” says the report. “Should the market drop 5%, all our stop levels would drop by 5% as well. This avoids triggering a bunch of stops in a correction and ending up sitting on a pile of cash.”
For more details on loss aversion, read Richardson GMP’s full report.
For full details on Turnill’s commentary and asset class views, read the full report from BlackRock.
For more on U.S. tariffs and the central banks, read the full RBC report.