With tax reform enacted, budget caps raised and regulation rolled back, the US Administration has shifted its focus to trade policy, which has turned more hawkish in 2018. That said, strong rhetoric has been diluted to relatively restrained, well-orchestrated and targeted actions thus far, and so we see limited near-term macro or market impact. We maintain our optimistic outlook for growth, and still see more potential investment opportunities than challenges. Within fixed income, we remain constructive on emerging market (EM) currencies and see little protectionism risk beyond China, and within equities, we think potential for slower global trade favors exposure to small-to-medium cap companies over large cap.
The White House has announced tariffs on a range of goods, from solar panels to steel (see Exhibit 1). The measures are unsurprising given US President Donald Trump campaigned on a protectionist agenda; however, the shift away from globalization creates a more nuanced and uncertain policy outlook, and introduces microeconomic costs such as loss of efficiency and productivity. On balance, we see limited near-term risk to global growth and markets as tariffs are mainly targeted toward China, with lower-than-anticipated scope and magnitude.
Source: GSAM As of March 26, 2018. Text in parenthesis denotes relevant section of US Trade Law.
In our 2018 Outlook we discussed the potential for more volatility after a benign 2017, and while the equity market correction in early February was greater and earlier than we anticipated, it was not unexpected. Looking ahead, a material escalation in trade tensions is not our base case; however, greater policy uncertainty may prompt further bouts of volatility and inject more risk premium into markets. Against a backdrop of still-healthy global growth and accommodative financial conditions, we think this presents more investment opportunities than challenges. Below we outline key investment views that are broadly associated with recent trade and volatility developments.
The balance of risks around our optimistic growth and benign trade outlook would shift materially if the scope and magnitude of tariffs were to broaden across countries and sectors, or if we encountered greater retaliation from China and other countries impacted. In this scenario, we believe macro costs would likely include higher inflation and rates, and lower global growth. So far, developments on both fronts suggest the economic impact of President Trump’s turn to protectionism may be relatively contained:
Last year we noted greater protectionism would reconfigure trade relationships and plot a new distribution of winners and losers. Fast forward one year, and we are reassured that a “Trade Showdown” has not played out. The US has withdrawn from the Trans-Pacific Partnership, pressed ahead with renegotiation of NAFTA and introduced targeted tariffs, but rhetoric appears to be toning down and measures may be insufficient to steer earnings and growth momentum off track. Global markets remain underpinned by healthy growth and accommodative financial conditions, but evolving US trade relations demonstrate that headwinds remain, and so we believe investors should continue to look beyond traditional asset classes and borders.