Don’t rush to take advantage of the big sell-off

[SINGAPORE] Investors who chased the S&P 500 higher immediately after US President Donald Trump was elected in November last year might now be wondering what they were thinking.

Within a fortnight of his inauguration, Trump announced import tariffs on Canada, Mexico and China. Last week, he imposed tariffs on most of the rest of the world.

In his executive order last Wednesday (Apr 2), he reiterated many of the grievances about global trade he had openly expressed on the campaign trail.

He asserted that the US suffers from lopsided bilateral trade relationships that have hollowed out its manufacturing base, undermined its supply chains and rendered its defence-industrial base dependent on foreign adversaries.

He also grumbled in the executive order that foreign companies are now better positioned to scale production, invest in innovation and compete in the global economy.

Despite widely telegraphing his intention to address this perceived unfairness, the import tariffs he announced seemed to catch many investors on the back foot.

The S&P 500 ended last week down 9.1 per cent, while the Nasdaq 100 was 9.8 per cent lower. The 10-year US Treasury yield sank to 3.99 per cent, from 4.26 per cent at the beginning of the week.

Markets around the world also took a beating: the Stoxx Europe 600 was down 8.4 per cent; the Nikkei 225 sank 9 per cent; and the Hang Seng Index fell 2.5 per cent.

Here in Singapore, the Straits Times Index was down 3.7 per cent.

One possible reason for the market’s negative reaction is that many investors might have assumed that Trump was only using the threat of tariffs as a bargaining chip; and they were perhaps more focused on the tax cuts and deregulation that his administration is expected to deliver.

Another possible reason for the widespread nervousness is that the tariffs were much higher than many investors expected. Trump imposed a baseline 10 per cent tariff on all countries, which took effect on Apr 5.

On Apr 9, a higher individualised “reciprocal tariff” will be imposed on countries against which the US is running trade deficits. All other countries will continue to be subject to the baseline 10 per cent tariff.

Among the larger economies that will be hit with these reciprocal tariffs are China, the European Union and Japan – they are to pay 34 per cent, 20 per cent and 24 per cent, respectively.

Apart from the tariffs being higher than expected, they also seem to have been set rather arbitrarily. Some observers have pointed out that the reciprocal tariffs were calculated by taking the trade deficit that the US runs with the country in question, and dividing it by the exports that country sends to the US. Then, to be “kind”, that number was halved to arrive at the reciprocal tariff rate.

The result is that some relatively small, low-income economies that trade with the US have been hit with high reciprocal tariffs. For instance, Cambodia is being made to pay 49 per cent, while Laos will pay 48 per cent.

More retaliatory tariffs?

Much now depends on how nations around the world react to the new tariffs. While Trump has threatened even higher tariffs on countries that retaliate, he has also left the door open for US trading partners to appeal for lower tariffs in exchange for something “phenomenal”.

Trade-dependent economies in South-east Asia have a great deal to lose, and are most likely to be wary of making things worse by retaliating, in my view.

Already, Indonesia and Vietnam have indicated a willingness to ease their trade barriers, and are now seeking to negotiate with the Trump administration. Indonesia and Vietnam have been hit with reciprocal tariff rates of 32 per cent and 46 per cent, respectively.

Similar responses from other nations in South-east Asia may enable Trump to claim that his gambit is working. This could ultimately see the Trump administration reduce its tariff rates on these nations, and help assuage the growing sense of panic in the markets.

Not every country is likely to take Trump’s tariffs lying down, though.

China said on Apr 4 that it will impose an additional 34 per cent tariff on US imports, and implement controls on the export of certain rare earths and the import of some agricultural products.

Canada said on Apr 3 that it would impose tariffs of 25 per cent on vehicles from the US. This was in response to the Trump administration’s tariffs on vehicles from Canada that came into effect that day.

Canada also announced tariffs last month in response to the Trump administration’s tariffs on steel and aluminium.

It remains to be seen if Trump will risk responding by imposing additional tariffs on these countries while global markets are in a tailspin. Doing so might be akin to pouring kerosene on the fire.

On the other hand, doing nothing might leave Trump looking feckless as well as foolish.

US dollar weakness

Against this uncertain backdrop, investors around the world are probably in for a rough ride.

Trump’s tariffs will almost certainly weigh on global economic activity and corporate earnings in the months ahead.

Even if some economies in South-east Asia manage to cut deals that lower their reciprocal tariff rates, the Trump administration’s general attitude towards trade has probably negated a major element of their growth story for investors.

It may also be just a matter of time before investors begin worrying about the durability of the US dollar as the pre-eminent global reserve currency.

One reason the US has been able to run large and persistent trade deficits is that the rest of the world has been happy to channel their US dollar surpluses into the US capital market. Trump’s inclination to bully friends and foes alike in order to reshape the global trading system, and enhance the US economy’s export competitiveness, could disrupt these global capital flows and have far-reaching consequences for financial markets.

Indeed, the greenback did not behave like a safe-haven currency amid the recent global market turmoil. The US dollar index – which measures the greenback against the euro, Swiss franc, Japanese yen, Canadian dollar, British pound and Swedish krona – slipped nearly 1 per cent last week.

The index has declined 5.8 per cent since Trump’s inauguration.

The way I see it, investors should not be in a hurry to take advantage of the recent market sell-off; and they should keep their Fomo (or fear of missing out) in check in the event of a relief rally.

It could be several months before the current shake-out runs its course.