Written by: Benjamin Mandel and Hannah Anderson
This is a distillation of a forthcoming J.P. Morgan Asset Management research paper: What is a trade war, and are we in one? Multi-asset implications by Benjamin Mandel, Global Strategist, Multi-Asset Solutions and Hannah Anderson, Global Market Strategist, Global Market Insights Strategy.
TRADE POLICY IS OF FIRST-ORDER IMPORTANCE IN A MORE CONNECTED WORLD, AND MARKETS HAVE BEEN REACTING NERVOUSLY TO U.S. TRADE DISPUTES WITH CHINA, EUROPE AND NAFTA COUNTRIES. Our latest research explores the portfolio implications of trade policy uncertainty, at a time when trade-related market shocks are becoming more frequent.1
Our baseline view is that trade policy uncertainty will continue driving higher levels of volatility but will not fundamentally alter the direction of markets over the next 12-18 months. Moderate, negotiated solutions remain our base case outcomes for NAFTA and China trade disputes. There is a rising risk, however, that if these disputes drag on or intensify, market reactions could become deeper and more persistent.
A key feature of trade disputes is the non-linear pass-through to economic outcomes. Small or narrow tariffs have generally had small effects on near-term growth and inflation. Combining all U.S. tariffs on Chinese exports (those announced and threatened), we estimate an effect of only about a 25 basis point (bps) decline in U.S. real GDP growth and 20bps on core CPI inflation. These are non-trivial but not devastating in an economy currently growing at an above-trend pace.
More severe problems would likely arise if trade barriers began to affect economic sentiment and damage private sector confidence—currently, business sentiment readings remain high, but at the margin they have begun to reflect trade fears. There is also the risk that the balance of winners and losers from tariffs has spillover effects. For example, the prospect of auto tariffs could be sufficiently threatening to dampen confidence. In addition to autos, the burden of U.S. tariffs under consideration will fall disproportionately on U.S. consumers of electronics made in China and on U.S. businesses utilizing imported machinery and metal inputs. Other countries’ retaliation will likely deliver the biggest hit to U.S. exporters of agricultural products and U.S. business operations overseas.
Thus far, these grave possibilities have been more fear than fact, and markets have cycled through trade policy episodes relatively quickly. By our estimation, a “typical” announcement effect over the past 18 months has corresponded to a 30bps fall in S&P 500 total return on the day of announcement, followed by a 1ppt cumulative recovery over the subsequent five trading days (EXHIBIT 1).
Some investment implications of our research include:
- Trade war headlines spark negative reactions for equities on impact (creating disproportionately higher volatility in emerging markets and Europe), and a temporary boost to the dollar.
- Trade disputes have been more pronounced in the more trade-exposed markets of Asia and Europe than in the relatively closed U.S., where assets also generally do relatively better in risk-off situations.
- Higher overall volatility, emergent downside risks and the lower relative sensitivity to policy outcomes support the U.S. at the top of our list of preferred equity markets; Europe is collateral damage in these disputes and among our least-preferred markets.
- Over the past year, duration has acted as a moderate hedge for trade shocks, with stock-bond correlations modestly more negative during recent trade risk episodes.
1 This note distills the investment implications discussed in a forthcoming research paper, “What is a trade war, and are we in one?” by Benjamin Mandel and Hannah Anderson, J.P. Morgan Asset Management (July 2018).
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