Trade of the century
Following the election of Donald Trump as the next President of the United States, investors should take note of the hidden costs of protectionism.
We believe that protectionism — the practice of shielding a country’s industry from foreign competition — and the prospect of a descent into a ‘beggar thy neighbour’ global trade war is one of the biggest risks to investment returns over the next decade, and it’s not getting nearly enough attention. Indeed, politicians are already succumbing: according to the Global Trade Alert initiative, the number of protectionist measures enacted globally in the first four months of 2016 was three times the average number of measures passed in the same period over the last decade.
Free trade has undoubtedly accelerated the broader process of ‘creative destruction’ and the corollary is greater disruption to working lives. If politicians wish to secure the benefits of trade for future generations they would do well to implement policies that soften the disruption, or else the nationalistic demagoguery of maverick, anti-establishment politicians could deliver shock results — to politicians and investors alike.
Taken at face value, protectionism provides a large, easy to quantify gain to a small but visible and vocal number of people. Yet it simultaneously delivers a small, hard to quantify loss for every member of a large and silent majority. The aggregated impacts of those small losses invariably far outweigh the ostensible gains. We highlight the countries most at risk of a protectionist insurgence: the United States and Italy are clear front runners. The consequences of these two economies sliding into popular protectionism would be grave and far reaching – the election of Mr Trump makes this far more likely.
A protectionist turn for American trade policy following the election of Mr Trump would lower our long-run expected returns on US equities via a weaker outlook for productivity growth. There are at least four emergency powers with which he could impose tariffs without congressional approval.
Protectionism would be likely to raise real interest rates, but reduce longer term growth – a bad combination for equities. More progressive policies to mend the broken covenant of globalisation could also raise real interest rates and could potentially raise growth – a net neutral to positive combination for equities.
At face value, high tariffs mean fewer imports and fewer dollars sold to buy foreign goods, theoretically appreciating the exchange rate. That said, over the long term, we believe that a protectionist turn would catalyse the reversion of the overvalued US dollar back toward our measure of the ‘equilibrium rate’, which would also be likely to shift lower.
- At a sector level, Mr Trump’s victory is likely to hurt companies with a high sensitivity to economic uncertainty, a high correlation with the US business cycle and a high proportion of earnings originating in China. Automotives & parts, general industrials, tech hardware & equipment and electrical & electronic equipment rank poorly across all measures. US manufacturers that source many component inputs from China would also suffer, and many of them are found in these industry groupings. Growth also outperforms value during periods of uncertainty.
- We also show the UK sectors most exposed to US revenue streams, its business cycle and most sensitive to US economic uncertainty. ‘Defensive’ sectors outperform when US uncertainty rises, but, interestingly many of these sectors also derive a considerable amount of income from US sales – over 35% in the case of pharmaceuticals and utilities.
- Finally we highlight some sectors that may benefit from Mr Trump’s victory – other than the relief rally in healthcare, those exposed to infrastructure and defence spending are most likely to benefit.