- Two developments, the G-7 meeting in Canada and the historic summit between President Trump and Kim Jong Un, have dominated the news in recent days. They have raised questions about a possible weakening of the post war order between the U.S. and its allies and the start of an era of diminished confrontation with North Korea. Yet, global markets have not reacted to either development.
- One explanation is they are likely to play out over a matter of years, and it is too early to know the final outcome. Another is that markets mainly react to geo-political developments that directly impact the global economy such as oil shocks or wars, but regard other developments as noise.
- My own take is that investors should not ignore the threat of a trade conflict that could unsettle the western alliance. Should conditions deteriorate further, the global expansion and bull market in equities would be at risk, although it is probably one or two years from now.
Background: Trump’s Election & the Post War Order
Shortly after Donald Trump’s surprise victory, I attended a conference in New York City among prominent investors to discuss the implications of the election for the U.S. economy and financial markets. The meeting concluded with each of the attendees presenting their personal assessments, most of which were upbeat based on Trump’s pro-business stance and the prospect for corporate tax cuts and deregulation. When my turn came, I concurred that tax and regulatory policies would boost stocks, but I also noted that Trump’s “America First” vision would increase uncertainty about relations between the U.S. and its allies. The reason: Trump has been a consistent critic of our trading partners for taking advantage of U.S. largesse since the 1980s.
While the administration focused on issues such as healthcare reform and tax policy during 2017, the focus this year has shifted to trade and international relations. The announcement in March that the U.S. government would boost tariffs on imports of steel and aluminum by 25% and 10%, respectively, caught investors by surprise, because they mainly applied to allies of the U.S., yet the justification was national security. While it appeared the sanctions would be dropped or suspended for certain countries, President Trump’s stance has hardened recently.
This became a bone of contention at the G-7 summit meeting in Canada this past week, which ended on a sour note, when President Trump declined to sign the communique and then went on to openly criticize Canadian Prime Minister Justin Trudeau for his remarks about Canada’s response to U.S. protectionism. According to press accounts, leaders of several European countries were incensed by what transpired, and there have numerous commentaries that President Trump’s stance is undermining the world order that has prevailed throughout the post WWII era.
These developments were followed by a historic meeting between President Trump and North Korean leader Kim Jong Un. Ironically, this meeting ended on a positive note, in which both leaders agreed to lessen tensions on the Korean peninsula. North Korea pledged to nuclear disarmament while President Trump announced he would end the regular military exercises the U.S. conducts with South Korea. However, there were few details about what new commitments had been secured from Kim, and it is widely believed negotiations will last for several years.
Minimal Market Response
While both developments have grabbed the headlines, there has been little or no market response to either of them thus far. One explanation is that investors see them as part of a long negotiating process between the U.S. and its western trading partners, as well as with North Korea. This is understandable considering no concrete actions were undertaken either at the G-7 meeting or the U.S.-North Korea summit in Singapore. Accordingly, many investors have concluded it will take several years before the final outcomes are known.
Another consideration is that investors mainly react to geo-political developments when there is a clear economic impact. Throughout my career that spans the past five decades, the most notable events that impacted financial markets were wars that resulted in oil supply disruptions and eventual recessions. Otherwise, the impact of geo-political developments on financial markets has been fleeting.
This poses the issue whether this will again be true if the conflict over trade escalates both with our allies and also with China. In my opinion, the stakes are too high for investors to ignore the risks entailed either if the spirit of cooperation with our allies is damaged or if the U.S. escalates the trade conflict with China. It is one thing for the U.S. government to negotiate to obtain a more level playing field in international trade. It is another thing to disrupt the multilateral trading system that contributed to peace and prosperity following World War II without any vision of how to improve it.
Finally, I do not foresee an imminent threat of a trade war that will unsettle financial markets in the balance of this year. However, the trade issue is unlikely to fade away, and it will become more difficult to find a solution over time. The reason: The overall U.S. trade deficit is set to rise in the next few years as the budget deficit expands. Accordingly, I view the risk of a trade conflict as the wild card in the outlook for the global economy and markets.