Who does not support the notion of “fairness”? Everything is better when it is endorsed. Even defeat is more pleasant when it is fair and square. It is one of those warm-blanket words that no one disputes. But the concept of fairness is becoming astoundingly complex when discussing world trade.
In this post, we return to a theme we revisit from time to time: the divergence of America’s policy path from the rest of the world. In the post-war period, free trade has become something of a sacred cow in the economics profession. Few challenge its benefits, and almost all – at least theoretically – support the unhindered movement of goods and services across national borders.
Of course, in practice, global trade doesn’t always happen in a frictionless fashion. But the so-called “comparative advantages” of each nation (where countries focus on their industry specialties and lower opportunity costs) support the theory that international trading partners are best served without trade restrictions. Each country plays by the same rules, fairness is upheld, and overall global economic welfare is improved. Everybody wins.
Yet this decades-old orthodoxy is now under siege. The resignation in early March of Trump’s top economic adviser, Gary Cohn, dealt a big blow to free-trade proponents inside the White House. Not many are left – certainly none as prominent as Cohn had been – to defend the economic establishment.
The main danger is that the rules may now be re-written, with the world moving from an era of liberal trade and open markets to one of growing protectionism. Full-blown protectionist policies in the U.S. (i.e., imposing tariffs, threatening to tear up trade agreements, and other unilateral actions) would not only be unprecedented in the post-war era, but would undoubtedly prompt retaliation from other nations and convince the world that the existing global trading system is unravelling. Such was the tenor of the tit-for-tat exchanges last month when President Trump announced the imposition of tariffs on Canadian and Mexican steel and aluminum, both of which countries had been granted temporary exemption.
If the shift continues, it would mark the largest and most dangerous change in economic thought and order in decades. Larry Kudlow, Trump’s recent appointment for director of the National Economic Council, has even identified the counterproductive nature of recent tariff action, referring to them wryly as “sanctions on our own country.”
On the one hand, you cannot blame the U.S. for acting in its own best interests. Trump has rightly identified some deep inequities in world trade. But the U.S. foray into protectionism will almost certainly be a pyrrhic victory. In a globalized world defined by a move toward closer interconnectedness, the “biggest loser” would be the U.S.
Chinese President Xi Jinping, who has worked steadily over the past four years to strengthen China’s position in Asia, likely views Trump’s retreat from globalization as his own triumph. Consider former President Obama’s “pivot to Asia,” with the Trans-Pacific Partnership being the centerpiece. It is now dead. That leaves Xi’s “Belt-and-Road” strategy (his own version of “Make China Great Again”) as the uncontested blueprint for future economic integration in Asia.
Ironically, China’s diplomacy now also offers a positive vision. In Davos last year, President Xi (a first-time visit for any Chinese president) defended globalization, positioned his country as a protector of free trade, and urged policymakers to “just say no” to protectionism. “Pursuing protectionism is just like locking one’s self in a dark room. Wind and rain may be kept outside, but so are light and air,” he said during his address. “No one will emerge as a winner in a trade war.”
In Europe, Emmanuel Macron’s presidential victory, with his La République en Marche party securing a record parliamentary majority, was won on a platform of pro-globalization, pro-free trade, and, importantly, potential federal solutions to the European Union’s (EU’s) structural problems (which could renew a cooperative Franco-German axis that had driven the EU project since the early 1950s). That contrasts starkly with Trump’s “America first” agenda, whereby the U.S. effectively withdraws as global country leader. Expect other leadership to continue to fill the hegemonic void left by U.S. nationalistic policies.
Investment implications
All may be fair in love and trade wars, but will the President Trump actually carry out extreme protectionist policies? The knee-jerk reaction may be to answer yes. After all, the president does have broad legal powers to restrict international trade, and he has already imposed tariffs on steel and aluminum (now including Canada and Mexico). And he’s shown no shortage of enthusiasm for trade brinksmanship.
Yet, several reasons suggest that Trump’s bark will be bigger than his bite. In the week where the first round of tariffs were delivered, Cohn resigned, and a huge public backlash emerged from at least half the Republican caucus in Congress. Corporate leaders also issued sharp rebukes against trade protectionism. It is also becoming clear that the President is curiously trying to protect a world that no longer exists – the manufacturing and industrial economy of the U.S. is long gone.
Most importantly, U.S. trade law provides an almost infinite range of possible policies. The Trump administration could easily take several trade measures that would draw huge headlines and appease supporters, but would not have a material impact on overall trade volumes (much as the Obama administration did with its aggressive pursuit of anti-dumping and WTO cases against China). Although this seems the most probable scenario, we continue to closely monitor risks.
Looking ahead, America’s waning leadership should contribute to the underperformance of U.S. equities relative to global indices. Since 2009, America’s stocks and its currency have trounced their global counterparts. From its low in 2009, the MSCI U.S. index has risen by roughly 400%, while the MSCI All Country World ex-U.S. index has risen by only slightly more than half as much.
However, we have argued in the past that U.S. equities are set to underperform. Three key drivers of U.S. equity outperformance are going into reverse:
1. In recent years the Fed was the most aggressive liquidity provider in the world – this is no longer the case. The Fed is now tightening, while almost everyone else is on hold.
2. In recent years the U.S. benefitted from an extraordinarily competitive currency – this is no longer the case. In a very short period, the U.S. dollar has gone from being significantly undervalued against almost all currencies, to being fairly valued against most, to now being overvalued against the likes of the euro and the yen.
3. In recent years U.S. equities were attractively priced – this is no longer the case. Where may the next phase of outperformance direct itself? Europe and Asia are the most likely candidates – regions that generally have cheap currencies, are showing signs of earnings and economic acceleration, and trade on much lower valuations. Who can argue with rotating into less expensive markets, where business cycles have only just begun their expansion phases, where profits have plenty of scope for improvement, and where monetary policy is years away from any substantial tightening?
Courtesy Fundata Canada Inc. © 2018. Tyler Mordy, CFA, is President and CIO of Forstrong Global Asset Management Inc. Securities mentioned are not guaranteed and carry risk of loss. This article is not intended as personalized investment advice.
