President Trump's endgame: No pain, no gain
Despite alarming headlines last week on further trade sanctions, most equity, credit and bond markets signal optimism on global growth.
Cheap emerging market valuations, hopes for a decent US earnings season and a belief that the President Trump should not be taken literally explain this resilience, says JP Morgan strategist John Normand.
"It is this last point on policy that deserves more thought: just what is the President’s endgame, and so how literally should one take his threats when developing business cycle scenarios and investment strategy?"
The analyst has always assumed that Trump should be taken seriously rather than literally, but last week’s escalation towards another US200 billion in tariffs challenges that belief.
JP Morgan's strategist has come up with four possible endgames – all of which carry quite different market consequences.
They are: Guaranteeing Republican success in mid-term elections, containing China’s long-term rise, securing China’s assistance with North Korea/Iran, and abandoning global institutions.
“These goals are not mutually exclusive, and the first and second seem like reasonable-safe assumptions,” Normand argued.
So far, so good
In a report, Normand says the first objective implies that the President intends to deliver on as many campaign promises as possible – tax cuts, immigration reform, protectionist tariffs, disarming North Korea, containing Iran – by early fall when the Congressional campaign intensifies, as long as these policies do not harm the economy, the stock market or the President’s popularity.
"So far, so good: tax cuts have lifted US growth, US stocks and the President’s approval rating more than geopolitics have dented these indicators.”
To him, the risk is therefore that an emboldened President will deliver on what were once thought to be hollow threats, such as 10 per cent tariffs on an additional US$200 to US$400 billion of Chinese imports plus measures to protect the auto sector.
Normand's second objective suggests a more chronic but narrower challenge for markets.
The strategist said containing an economic and eventual geopolitical rival requires more than tariffs which is why the US is also considering limiting technology exports to China, restricting Chinese investment into strategic US sectors, and pushing for intellectual property right enforcement.
“As long as the Trump worldview persists, the more investors should question the headline growth outlook for China.”
Yet, Normand believes a narrow US geopolitical agenda focused on containing China seems like more an issue for the valuation of China-related assets like the renminbi, metals markets, resource stocks and Chinese equities than it is an issue for global markets.
“This campaign would need to be waged over years rather than months, with the only good news being that the duration of US pressure may turn on who prevails in the next US Presidential election.”
The third objective is a similar to the second.
In Normand’s opinion the longer China is seen as frustrating the US attempts to bridle North Korea and Iran by trading with those countries, the more the US might prove willing to increase trade sanctions on China.
“But even assuming Chinese assistance with these two regimes, the current US administration is unlikely to rethink its view that China itself must be contained through a variety of tactics.”
Thus, the market implications of a chronic standoff around North Korea, for example, should be similar to the second scenario.
Lastly, a scenario which might entail a permanent institutional shift like US de facto or de jure withdrawal from the WTO, would be the most destructive to global markets through a supply shock that delivers a US recession.
“The conventional wisdom is that this threat too is mere bluster from the country that architected the current international order, so is intended to motivate a reduction in global trade barriers rather than a return to them.
“But what sounds like anathema today can morph into something sensible the longer a conflict ages and a system fails to deliver its purported benefits.”