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Markets are right to be pricing the risks of trade wars

24 April 2018

James Bateman, CIO, Multi Asset, Fidelity International assesses the short and long term risks of trade tensions and says it is possible we will see another move down in markets.

Trade tensions between the US and China have been at the forefront of investors’ minds in recent weeks. Both sides have engaged in a war of words and retaliatory measures, leading many to fear that we are at the beginning of an escalating trade dispute.

While I think markets are right to be pricing the risks in, I think current tensions are unlikely to lead to an end of today’s bull market. The economic backdrop remains robust, even if we have seen a slight moderation in the data over the past couple of months. Unless we see a significant escalation, such as China devaluing the renminbi, we are unlikely to see a permanent knock to risk sentiment.

However, it is possible we see another move down in markets, even if this is not my base case. At its lows, the S&P 500 has only reached back to where it was in October last year. Many investors will view the gains of the past six months as transitory, having barely had enough time to register their returns to begin with. But a further leg-down could be a great buying opportunity for the final phase of the bull market.

For markets to be seriously concerned about trade, we would likely have to see contagion across other asset classes. Currency, bond and commodity markets have been relatively well behaved however. Volatility across equity markets might be more to do with investors taking profits after a strong run and factoring in a slight moderation in data, as well as geopolitical risks.

If investors do want to factor trade tensions into their thinking, they need to consider whether ‘trade volatility’ is something that will worry you in the long term, or if it is more short-term noise. If it’s the latter, then you should probably not adjust positioning. But if you believe current tensions are the beginning of a much more hostile trade environment, you should reconsider exposure to economies particularly dependent on global demand, such as Japan. Closed economies like India will look relatively more attractive to investors.

Ultimately, however, a little trade tension might be healthy. Pressure on China for it to allow greater access to its domestic market might end up a positive for some US companies, even if they face fiercer competition over the long term. Similarly, demands for Germany to reduce its surpluses would help to lead to a more balanced European — and global — economy.

In the meantime, investors should prepare for trade tensions to remain elevated. Trump appears to be playing to his base ahead of the US mid-term elections, and will want to show that his aggressive stance has delivered, even if it is cooler heads who ultimately resolve trade issues.

 

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