Should investors prepare for a global trade war?

Graham Smith
Graham Smith
Market Commentator9 March 2018

One thing you can say about Donald Trump – he hasn’t forgotten his core vote. Whether speaking to a liberal, globalised audience in Davos or Republicans on Capitol Hill, Trump’s world view pays homage to the disenfranchised, disenchanted and dispossessed in American society that helped propel him to power.

For a businessman, this makes good sense. Know your customers and look after them well. No matter that America’s tax cuts favour the rich the most or that imposing new tariffs on steel and aluminium imports might make consumer goods dearer, these are policies designed to create jobs and breathe new life into the country’s post-industrial heartlands.

In Davos, Trump eschewed a globalised response to present day challenges. Instead he put America first and invited the rest of the world to come along. What would be good for America would be good for the rest of the world too. 

Trade wars, however, do not fall into this category. Research shows that global trade and living standards are interlinked, as we might expect1. So fortifying your economy against cheap imports is likely to seriously backfire if your aim is to improve the lot of ordinary citizens.

Already the European Union has responded to Trump’s plans to put tariffs on metal imports saying it is considering imposing retaliatory tariffs of its own, on iconic US products like Levi jeans, Harley-Davidson motorcycles and bourbon whiskey 2.

Recent history shows tariffs on steel can have seriously unwanted outcomes. When President George W. Bush tried the same tactic in March 2002 after a multitude of US steelmakers had been forced into bankruptcy, the World Trade Organization ruled the tariffs illegal, clearing the way for the EU to press for US$2 billion in sanctions.

In an eerie parallel with today, the EU was threatening tariffs on key US exports aimed at producers in key marginal states, like Florida’s citrus fruit growers3.

Immediately after the introduction of Bush’s tariffs, the US stock market fell substantially and didn’t level off until the autumn4. While other forces were undeniably at work at the time – for example, markets were still reeling from a brief recession in 2001 and eyeing the growing likelihood of a war in Iraq – tariffs were widely understood to have been an important contributory factor.

The tariffs were eventually revoked in December 2003 under the withering combined pressures of the WTO, markets and the EU5. This time, steel prices suggest the most difficult times for America’s steel industry and steelworkers are already in the rear view mirror. US prices of hot-rolled band steel have more than doubled since their post-crisis lows, as have world export prices of the same material6.

While some of this rise may be down to expectations of US tariffs – which would make production in countries other than America less attractive – the largest part of it is most likely attributable to rising global demand.

With the next phase of Trump’s grand plan – a massive build-out of American infrastructure – waiting in the wings, the demand for industrial metals could be about to see another major leg up and further improvement in trading conditions for America’s steel mills.

The construction industry already accounts for about 40% of US demand, with automakers in a relatively distant second place at 26%7.

Moreover, something we know about Trump is that he follows America’s stock markets closely. He routinely links the recent strong rise in US stocks to his presidency. If anything like the response from markets to the Bush tariffs was to transpire, it’s hard to see how he could live with that.

Even so, following proclamations signed by Trump yesterday, US import tariffs of 25% on steel and 10% on aluminium are set to come into effect before the end of this month8. While there remain hopes countries with close security relationships with the US will be exempted – along with Canada and Mexico while NAFTA talks progress – it’s another reason to expect markets to remain more volatile and directionless than they were on average last year.

That could prove a challenge for investors with index-like market exposures, be that via passive funds designed to track market indices or even active funds with closet index exposures.

On the other hand, funds designed to deliver positive returns in varying market conditions – absolute return funds – or highly active funds with a minimal reference to global indices have the potential to fare better.                                                                                                                             

From an international perspective, Europe’s attractive valuations compared with America could lend support should current high levels of market confidence falter.

Fidelity’s Select 50 list encompasses a range of actively managed funds that deviate substantially from the headline market indices. In the UK, such funds include the value oriented Fidelity Special Situations Fund and growth focused LF Lindsell Train UK Equity Fund. The managers of these two funds talk about their investment style in the latest episode of MoneyTalk.

Globally, the Rathbone Global Opportunities Fund is a likewise-minded, bottom-up stock selector. Choices in Europe with strong style biases include the FP Crux European Special Situations Fund and the Invesco Perpetual European Equity Income Fund.

Sources:

1 Frankel and Romer, American Economic Association, June 1999

2 Bloomberg, 06.03.18

3 New York Times, 11.11.03

4 Wall Street Journal, 06.03.18

5 BBC News, 04.12.03

6 Steelbenchmarker, 26.02.18

7 Statista, May 2017

8 BBC News, 09.03.18


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