'No one wins from a trade war' - A $2.5 billion portfolio manager explains why markets could plunge further into chaos if Trump's standoff continues
- Major US equity indexes dropped more than 1% Tuesday as President Donald Trump threatened an all-out trade war with China.
- Kevin Caron, a senior portfolio manager at Washington Crossing Advisors, where he oversees $2.5 billion, explains how continued trade disagreement could plunge the market further into chaos.
It wasn't supposed to be like this.
When the prospect of a global trade war flared up and then quickly faded roughly two months ago, investors figured they were in the clear. It seemed like cooler heads had prevailed, which allowed them to to continue chasing returns by piling into risky assets as if nothing had happened.
But those worries have come flooding back this week as President Donald Trump reignited trade war tensions, raising the very real possibility of major retaliation.
The damage has been swift and widespread, with all major US indexes dropping more than 1% Tuesday, and the 30-stock Dow Jones industrial average shedding more than 400 points in early trading.
The severity of the selloff, which started on Monday amid rumblings that a trade war was re-emerging, speaks to just how unexpected this development has been, says Kevin Caron, a senior portfolio manager at Washington Crossing Advisors. The same investors who sounded the all-clear months ago are now scrambling for cover as the peripheral wreckage piles up.
"The risk-off trade is coming to the forefront as investors respond to another flare-up by seeking safety," Caron, who oversees $2.5 billion at Stifel Nicolaus subsidary Washington Crossing, told Business Insider by phone. "The stock market doesn't like any disruption on that front, because no one wins from a trade war."
Also troubling Caron is the unprecedented nature of the mounting trade conflict, which is unique in two ways. First, it simply hasn't happened to this degree in modern history. And second, it marks a rare occasion that two global super-powers are negotiating in a public forum, outside the confines of the World Trade Organization.
Caron is also leery of the downside risks associated with a major disruption to global trade, given how much is riding on a healthy system. Any sort of a breakdown can be not only financially disastrous, but also put a large dent into investor sentiment.
"We don't have a lot of history of understanding how markets behave in the face of trade wars, especially in the modern era, because we just haven't had them," he said. "It's dealing with something that's very different, that could potentially affect trillions of dollars in global trade, which most people have seen as an engine of growth in the last 40 years or so. And it's coming out of left field."
Another Wall Street expert who's surely displeased about these latest trade developments is JPMorgan quant guru Marko Kolanovic. In a client note published earlier this month, Kolanovic calculated the immense financial cost that could stem from Trump's refusal to nail down global trade terms.
He calculated that US equities had already absorbed a 4.5% gross hit - give or take 1% - which came out to roughly $1.25 trillion of "value destruction" for American firms.
Kolanovic's advice to Trump was to avoid roiling investor sentiment further, and he stressed that the president still had time to turn things around. Based on this week's events, it doesn't appear as if Trump is looking to cooperate.
However, it's not all doom and gloom, even for Caron. While he acknowledges that the sharp risk-off behavior that's characterized recent market activity is painful in the short term, his broader view is less drastic.
In Caron's mind, if analysts were truly expecting a major slowdown in global growth, they'd be trimming forecasts for profit expansion. Instead, earnings are expected to remain robust through the end of 2018 into 2019, at least for now.
So as you assess what to do next, perhaps look beyond temporary market fluctuations and focus on the engine of the market: corporate earnings and economic growth. If either of those things start flagging, then you'll know it's time for some wholesale portfolio changes.
"Markets haven't corrected significantly, which tells me markets aren't expecting this to boil over into a real significant setback for the global economy," said Caron. "As time ticks on, you'd expect to see behavior that's moving towards consensus negotiation. If you don't, and we keep heading back to the bargaining table, I think you're going to see more volatility."