Tom McCabe: 'US tariff crusade fuels investor headaches'
So far this year, investors have made impressive gains, a stark contrast to their sharp losses in the final months of 2018. Two factors above all have shaped investors' volatile journey over the past year: the trade war between the US and China, and the evolution of central bank policies.
As we move further into the second half of 2019, investors will need to keep a close eye on both issues, as they remain critical to how markets will perform.
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Occasionally, shifts in investor sentiment can dictate market moves much more so than economic or market fundamentals. The first half of 2019 was a good example.
The recent performance of the global economy has been a little underwhelming. Even after weakening its currency, cutting taxes and freeing up bank lending, the Chinese economy has still struggled to rebound from Donald Trump's trade tariffs. This has also held back many of the key Asian economies and, indeed, the eurozone, given its greater reliance on trade.
First-quarter GDP reports in Europe hinted at an improving outlook, but were likely artificially boosted by businesses racking up inventories in anticipation of Brexit-related supply disruptions post-March 29. Thankfully, the US economy has remained resilient. The US has certainly slowed over the past year but this should be expected, as the impact of the 2018 tax cuts fades, and overall recession risks still appear low.
Despite this mixed economic picture, markets have rallied this year primarily on the back of central banks' U-turn on interest rate increases. The European Central Bank now looks on the cusp of cutting interest rates, following the recent cut from the US Federal Reserve. Indeed, across the world, from India to Azerbaijan, lower interest rates are becoming the norm. This boosts the market outlook for investors but means continued low returns for savers in the foreseeable future.
An initial thaw in trade tensions also helped overcome investors' economic angst in the first half. When president Trump extended the deadline for Chinese tariff increases in February, investors assumed the next step was a trade deal that would put this issue to bed once and for all.
Not only has this not come to pass but Mr Trump's next moves became even more unpredictable, thanks to threats on Mexico and China. The US was unlikely to impose tariffs on Mexico, given the massive headaches it could cause for industry supply chains crossing the border.
Political support for this measure was also thin on the ground. However, the trade battle with China is very different. And it's a development that investors should pay particular attention to.
As we look to the second half of the year, to our mind, US-Chinese trade is the biggest swing factor for investors.
We estimate that tariffs have already increased the cost of Chinese exports to the US by around 17pc compared with the pre-trade war environment. In our view, the impact this could have on China, and by extension the global economy, already justifies the U-turn from central banks. Were China and the US to agree a trade deal, then this would be a clear positive for investors, allowing them to refocus on market fundamentals, which should be the primary concern at this later stage of the market cycle. We still believe a deal can happen but that this could take longer than initially anticipated.
However, further Chinese stimulus and a much looser approach from central banks would likely be required if the trade war intensified. If tariff rates were increased again, or tariffs placed on all US exports, this would place additional strain on the Chinese economy, not to mention companies where China is central to supply chains. The risk of Chinese reprisals also grows as its economy and companies (Huawei) are increasingly targeted. For investors, this has the clear potential to increase market volatility.
In this scenario, central banks would have to take centre stage. A more accommodative approach would be needed to safeguard the global economy and investment markets. Clearly, investors don't want to see this scenario play out, but we're confident central banks would act even more decisively if it did.
Market volatility has certainly increased thanks to Mr Trump's trade crusade. This issue looks set to remain a defining factor for investors to watch out for over the next number of months.
We remain optimistic that the US and China can hammer out a deal, but this may take time. In the interim, it is essential that central banks stand ready to shield the global economy from any trade war collateral damage. So far at least, it appears that they have investors' backs.
Tom McCabe is global investment strategist at Bank of Ireland Investment Markets