High volatility continues to affect world financial markets. So many outcomes, it seems, have become unpredictable – from U.S. trade policy to FIFA soccer matches. Should one be concerned? Actually, recent market gyrations do not catch us surprised. To start, market volatility, selloffs, excessive surges, and periodic crises are all normal. Historically, U.S. equities tend to have 10% declines every nine months on average. Nevertheless, investors must not lose sight of context nor become complacent with current conditions. Clearly, the potential tremors of a global trade war are top of mind, especially so for Canadians. As such, allow us to share our perspective on this topic.
In the post-war period, free trade became something of a sacred cow for economists. Few challenged its benefits, and almost all supported the unhindered movement of goods and services across national borders.
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) supports the theory that international trading partners are best served without trade restrictions.
Yet this decades-old orthodoxy has now come under siege. Since taking office in early 2017, the Trump administration exited the Trans-Pacific Partnership, demanded NAFTA revisions, and announced tariffs on numerous imports. The resignation in March of Trump’s top economic adviser, Gary Cohn, dealt a big blow to free-trade proponents inside the White House. Now, with the U.S. singling out China, the threat of a trade war between the world’s two largest economies has unnerved investors.
Although the economic impact of recently proposed trade actions is actually quite small, the main danger is that the rules may now be rewritten, with the world moving away from an era of liberal trade and open markets. Full-blown protectionist policies in the U.S. would undoubtedly prompt retaliation from other nations and convince the world that the global trading system is unravelling. Such a shift would mark the largest and most dangerous change in economic thought and order in decades.
However, it is imperative to delineate aggressive rhetoric from real underlying motives and intentions. While Trump has stated that trade wars are “good and easy to win,” the reality is that America has worked hard to shape the global trading system, and U.S. multinationals have benefitted immensely. While Trump’s base may cheer “America first” policy-making, such actions are largely to their detriment.
Rising import prices will disproportionately hurt lower-income households, while jobs are unlikely to return to the hollowed-out U.S. manufacturing sector. Free trade has been a staple of the GOP platform with past Republican presidents including Reagan and both Bushes embracing globalization. This ideology remains intact as Cohn’s resignation drew condemnation from at least half the GOP caucus in Congress.
Accordingly, we believe Trump’s bark will be worse than his bite. Trade threats will likely continue but are more likely aimed at drawing concessions from trading partners than instigating an all-out trade war.
While the recent global equity selloff may present selected buying opportunities, we prefer to maintain a balanced asset-mix approach while closely monitoring developments between the U.S. and global trading partners.
From a regional perspective, our preference for equities in Europe and Asia has been further strengthened. In today’s highly interconnected world, we believe the perceived instigator of trade tensions will ultimately be the “biggest loser.” Further nationalistic actions from the U.S. would likely strain domestic households, erode US multinational companies’ earnings, and encourage trade partners to diversify their export bases. If the U.S. withdraws as a global country leader, expect other leaderships (namely China) to fill the hegemonic void.
What to do
It is during times of volatile markets that the role of disciplined portfolio management is most appreciated. Rather than feign flawless clairvoyance, the portfolio manager is mandated to anticipate probable risks, prepare for opportunities and, most importantly, not to lose perspective when everyone else has lost their head. Either behavioral extreme – fear or complacent high expectations – are to be restrained through research and perspective. Emotions repeatedly prove themselves to be short on reason and lead to wrong conclusions. Why?
More often than not, large declines from a previous market high tend to lead to capitulation. Invariably, that leads to a strong rebound. Navigating these dynamics requires a disciplined framework that can extract emotion from the decision-making process. A such, Forstrong’s investment team will not waver in its approach – no matter the intensity of investor sentiments.
Looking ahead, the best possible defense against market volatility continues to be wide global diversification with an orientation to the longer-running macro themes playing out in the world economy (for example, the rise of the Asian consumer, demographic trends, urbanization, etc.).
Our global ETF portfolios have already been positioned for shifting trends and regimes with an ultimate goal of avoiding the “big mistakes” and continuously adapting in an era of new realities.
We believe that remains the best way to secure your financial futures.
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.