Mark Lister, 26 August 2019

Things took a turn for the worst during last week’s Friday trading session in the US, and we should expect a rough ride in the coming days.

First up, Federal Reserve Chair Jerome Powell didn’t go as far many had hoping during his speech at the Jackson Hole conference. Powell acknowledged the economic outlook had deteriorated and that risks were rising, noting that the Fed will act appropriately to sustain the expansion.

That’s all we should expect from the Fed, but market expectations were high and some were hoping for more explicit guidance around potential rate cuts in the coming months.

Few were more disappointed than President Trump. He took to twitter to vent his frustrations, calling Powell ‘the enemy’ and using plenty of capital letters to reinforce his dissatisfaction.

trump tweets

That was only the beginning, with China shortly afterwards announcing its latest retaliation in the long running trade saga between the world’s two biggest counties. Some US$75bn of US goods will attract tariffs of between five and ten per cent, which will hit autos and related components most harshly.

Already angered with Powell’s inaction, Trump quickly responded with a directive for American companies to immediately find an alternative to China. Vietnam and Mexico are viable alternatives to manufacturing bases in China, but not overnight. A number of US affected businesses have also pointed out that the ultimate cost of these trade tensions will be borne by US consumers, rather than China.

These developments saw the major US sharemarket indices finish sharply lower, with the Dow Jones Industrial Average off more than 600 points and S&P 500 more than 2.5 per cent lower on the day.

After the market had closed, Trump returned fire with some increased tariffs of his own. A series of tweets detailed that existing duties on US$250bn of Chinese goods will increase from 25 to 30 per cent, and that the upcoming tariffs on another US$300bn of goods will now attract a 15 per cent duty, rather than 10 per cent as originally planned.

We should expect a rough week ahead, as investors ponder just how high the stakes have been raised. In addition, most other markets were closed when the drama was unfolding on Friday, while much of the details didn’t come until after the close.

We’ve long thought the trade spat between the US and China could drag on for some time, and the recent escalation confirms it will get worse before it gets better.

Both sides have plenty to lose, with a decent chunk of global growth likely to be eroded should things continue the way they are. If it develops into a full-blown trade (or currency) war, the negative impact on activity, sentiment and supply chain disruptions could indeed push the world into recession.

The US economy is in a stronger position over the near term, although it’s harder to pick a winner over longer timeframes.

As a state-controlled economy China arguably has more levers to pull, while its citizens are certainly more accustomed to making sacrifices for the greater good. President Xi Jinping also has time on his side, given his term as leader is indefinite while President Trump has an expiry date.

As scary as the current escalation feels, we can’t rule out an eventual deal of some sort. There’s an election in the US next year, and recessions, cost increases and sharemarket collapses aren’t usually vote winners. This certainly won’t be lost on someone as astute as Donald Trump.

However, we shouldn’t necessarily count on sanity prevailing. When politics and egos are involved, anything can happen.

Until then, don’t panic but do take cover. We’re likely to see a ‘risk off’ tone prevail in the short-term, which means shares could suffer and haven assets like government bonds, good quality fixed income and gold will do well.

Higher risk currencies like the NZ and Australian dollar tend to fall in periods like this, while the US dollar, Japanese yen and Swiss franc do well. Commodity prices often weaken, given they are leveraged to global growth, so keep an eye on oil and dairy prices.

Within shares, defensive sectors usually outperform during periods of volatility. Cyclical and economically sensitive companies generally find themselves worse off, as do smaller companies compared with their larger peers. The New Zealand market usually holds up better than most, given the dominance of more predictable, income-generating businesses.

Those with well diversified portfolios appropriately matched to their risk profile need not worry, you’re likely already wearing all-weather clothing. However, if you feel over exposed don’t be afraid to take some profits and reduce risk. It’s not a bad time to touch base with your adviser and check if any fine-tuning is required.

For newer investors sitting on cash who’ve been wary of investing at record highs, bide your time and cross your fingers we see a bit more downside from here. Those are the periods when you get your chance to pick up some good assets at more reasonable prices.