Short and Sharp: Everything is not okay


Seema Shah

Another tweet, another big market move. Last Friday, as many investors were making their peace with reallocations towards expensive safe havens, defensives, and higher quality assets, President Trump turned things on their head again by tweeting that he had decided to suspend tariffs on Mexico (announced a mere week earlier). Risk assets promptly rallied, but can this be sustained?

Given the sheer unpredictability of Trump’s tweet-scapades, let’s focus on the fundamentals. U.S. macro data continues to deteriorate—with core durable goods orders weak, capital spending slowing, the manufacturing PMI down sharply, and signs that the jobs market is finally starting to falter.

Some investors seem to believe the recent weakness is due to the re-escalation of trade tensions and so will reverse if tensions fade. Actually, most of the numbers reflect activity prior to the May 5 tweets—a slowdown was already underway.

Of course, the outlook isn’t as bad as it could’ve been if tariffs on Mexico had materialised. But just Trump’s willingness to weaponize tariffs for other domestic and international battles inflicts meaningful economic damage. Where else will he deploy this tool? And, even if there’s an agreement with China, what’s to say that Trump won’t re-impose tariffs at a later date? Such uncertainty weighs on companies, prompting many to pause overseas investment plans, risking global capital spending and damaging business sentiment.

Easier monetary policy would make things better, right?

Historically, the first Federal Reserve (Fed) cut triggers a kneejerk market rally. But after digesting what the decision means—slowing growth—that quickly evolves to a red flag for stocks. On the other hand, failing to deliver the cuts that the market expects would lead to such negative market reaction that the Fed’s hand would likely be forced anyway.

What’s more, while it needs to signal it’s ready to respond if economic activity deteriorates further, the Fed must also be cautious to the fact that the trade battle could be reversed, via 280 characters, at any moment. Not to mention the unshakeable feeling that, cutting interest rates and thereby providing support to risk assets may simply encourage the Trump administration to extend, or even double-down, on the trade war. The Fed is cornered.

So how should investors position themselves? With business sentiment fragile, the underlying economy slowing, and earnings growth likely to follow suit, investors should fade the recent equity market rally. A Fed cut may see some short-term celebration, but that won’t be sustained as the economy weakens.
Yet with no recession in sight, there is still reason to be in risk assets – especially considering that a constructive trade tweet could be just around the corner. Find a home in defensives and high-quality risk assets. But they are so expensive, I hear you cry! They are, but they will become even more expensive as economic indicators weaken.

I would, however, be wary of increasing exposure to government bonds. Markets are pricing almost three cuts by end-2019 and almost four cuts in the next 12 months. These are extremely steep expectations: the Fed has only ever delivered such aggressive policy loosening when the U.S. economy was already in recession. While risks have clearly increased, a recession still isn’t in our base case.

It’s a tough time to be an investor.

By Seema Shah, Global Investment Strategist

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