Making Sense of Protectionism
Turning Possibilities into Probabilities
Stephen Hawking 1942-2018 “Try to make sense of what YOU see….” And not necessarily what you are told or want to see.
In a week where we lost one of the greatest minds of our time, markets pretty much shrugged off further signs of political instability from even more Trump sackings, the Japanese Abe scandal, the Irish border Brexit hurdle and the alleged Russian assassination of a spy just up the road from me. Markets remain range bound with the notable exception of the Canadian Dollar which continues to suffer from the possible fall out from Trump tariffs. One reason is that despite all this uncertainty, the world economy is ticking along nicely with stable if not rampant growth and relatively low inflation. There is no apparent need yet for any real divergence amongst G7 monetary policies and therefore an end to seemingly stable currencies or shake the aggressive stock uptrend of the last eight years.
Indeed this week’s US CPI highlighted the Goldilocks state of the US economy.. not too hot not too cold.
The issue for next week is twofold.
Firstly, how the markets will react to a widely discounted Fed rate hike and any direction Jay Powell gives for dot plots into 2019. After all, to what extent can you have buy the rumor sell the fact in a range? There has been one instrument at least that been waiting for this event to inject some instability and volatility: Gold. As the market’s focus shifts to inflation/rates, Gold is driven more by yields than the Dollar. This is shown clearly in the FOMC fractals available on our website tomorrow and indeed our forecast and trading strategy for Gold in the next 10 days.
Secondly whether this rate hike expectation has been delaying a wider and more sustained reaction to Trump Tariffs.
The aim of today’s newsletter is to show what, if any, conclusions can be drawn from previous protectionist acts.
Markets hate uncertainty, particularly political uncertainty and notably that surrounding US protectionism. The question of whether the Steel and Aluminium tariffs are just the first in a series from Donald Trump or indeed retaliatory measures from other countries would seem important in gauging the impact of Protectionism on markets. Not least for the likes of Canada whose GDP is two thirds reliant on trade and 20% from the US. Commerce Secretary Ross’s comments this week are encouraging that a renewed NAFTA is in the pipeline and therefore exempting Canada from any US protectionist measures. However, market reaction historically to Protectionism has not depended on the scale or duration. It has been varied.
DJIA since 1900
Dollar Index since 1980
US 10 Year Yield
It is difficult, if not impossible, to draw any conclusions from a comparison of ALL the different protectionist American acts since 1890. Many were introduced early in a Presidential term (Taft, Harding and Johnson in the first month and Reagan after three months) suggesting the President either felt he had a mandate or the confidence or indeed an agenda for a potentially controversial measure. They were clearly a function of the political and economic conditions prevailing at the time and clearly varied as evidenced by this 120 year historical DJIA chart.
At best one can conclude that protectionism was high on the agenda during or shortly after periods of stock market consolidation. But that somewhat tenuous observation doesn’t necessarily imply causality. On average, the DJIA has fallen immediately on the introduction of the tariff, consolidated or even rallied in the 60 trading days after then fallen for a three month period.
Similarly there is little relationship between the incidence of tariffs and key economic variables.
There has been a tendency to introduce tariffs after a slowdown in economic growth similar to DJIA consolidations and they have also triggered or possibly just coincided with a mild pick up in inflation. But there is surprisingly no clear correlation to the Trade Balance. Tariffs have been implemented more in times of a falling deficit than a deterioration such as now. But part of that improvement can be attributed to a previously falling Dollar, the most obvious consequence and remedy to a trade deficit. In this respect tariffs can be seen as part of a dual macroeconomic policy with the USD to address such issues as the trade balance. This leads to an interesting conclusion.
Protectionism or the anticipation of protectionism actually leads to an initial strengthening of the USD as it ceases to be the primary tool in tackling the trade deficit. But because its impact is selective and generally has little effect ie fails it leads to a further depreciation in the USD on average three months later.
Using averages does not account for the idiosyncrasies of the time or indeed the time lags between initial discounting of an expected protectionist measure and its implementation. Yet to some extent averaging out can lead to clearer general conclusions particularly when they are consistent with and reinforce outlooks and trading strategies based on other factors.
It may be coincidence that Trump has introduced steel tariffs at a slightly later point than Bush did in our long standing Pandora Box’s analogy for the USD (1996-2004). It may also be coincidence that notion of tariffs were introduced very close to the end of 1920s and 1980s stockout blowout and helped contribute to the ensuing crash.
But it does make you wonder why allegedly inflationary protectionism would lead to a collapse in bond yields 100 days later.
Whatever Jay Powell does about inflation at this week’s FOMC meeting and whatever Donald Trump does along the protectionist route, our strategy and outlook remains clear.
Stephen Hawking also said “The past, like the future, is indefinite and exists only as a spectrum of possibilities.” Our aim is to turn those possibilities into probabilities and, in 2018, do exactly what Paul Tudor Jones did in 1987 and “find where you can skew reward risk greatly in your favour”.
Here’s to making the very best.