United States president-elect Donald Trump’s promise to hike tariffs when he assumes office poses a real conundrum for world markets because he is known to drive a hard bargain. “The scale and scope (of the tariffs) remain to be seen, but the road ahead is bumpy,” says Reuters. Yes, specifically for global markets.
The timeline in 2018/19 during the trade tensions between the US and particularly China provides an indication of how bumpy the road ahead may be. However, not all threats of tariffs or threats of retaliation have a major or lasting impact on markets.
I identified nine catalysts (trade war escalations and de-escalations) that had a major impact on global stock markets in the said period.
On 22 January 2018, President Trump approved global safeguard tariffs on imports of solar panels and washing machines. China’s announcement of its investigation into US exports of sorghum a few days later caused panic in the markets. The CBOE Volatility Index or VIX (higher volatility, reflected by VIX, indicates a greater perceived market risk, and market participants are willing to pay more for insurance against large upswings or downswings) soared to 37 from 14 the prior week. The US stock market (S&P 500 index) fell by about 7%.
Following Trump’s announcement of the forthcoming tariffs on 1 March, the markets sold off until China imposed its retaliatory tariffs in early April. The markets gained traction again, while volatility remained subdued, despite much noise and tensions between the US and its trading partners. However, it took about seven months for the S&P 500 to recover the lost ground from January’s high.
Stock markets reeled shortly after US tariffs on $200 billion of Chinese imports and Chinese tariffs on $60bn of US imports went into effect on 24 September 2018 as volatility spiked. The markets were characterised by wild swings, and volatility remained in anxiety territory until the end of December 2018. The market was unfazed by Trump’s indication early in December of a possible truce with China and was more worried that the Federal Reserve’s independence may be under threat.
At the end of January 2019, calm on the tariff front was restored after Trump expressed hope for a deal before the end of March and was presented with an optimistic letter from Chinese President Xi Jinping (CNBC).
The breakdown in talks and the tariff hikes by both the US and China in May and August that year were the main catalysts for major spikes in market volatility and sell-offs.
On 11 October 2019, the US announced the so-called Phase 1 trade deal with China. From just before Trump imposed the Safeguard Tariffs (22 January 2018) to the eventual trade deal, the S&P 500 ended 3% higher, but investors had to endure a drawdown of more than 20% at one stage (October to December 2018).
It is important to note that the average drawdown of the S&P 500 after a major event (trade war escalation) was about 7%, and the drawdown lasted about 17 business days on average. In comparison, the average drawdown of both developed market equities (MSCI World Index in US dollars) and emerging market equities (MSCI Emerging Market Index in US dollars) was 6%. In contrast, the dollar gold price increased by 3% on average.
It is evident that investors are facing a protracted period of discomfort, characterised by numerous stop/go situations where sentiment changes from risk-on to risk-off strategies. But in general, an environment of high volatility and low stock market returns awaits.
It will require discipline to navigate the approaching US tariff tug of war.
It is crucial to plan ahead for spikes in market volatility, particularly against a backdrop of still-elevated stock market valuations and the rout in some global bond markets.
Do not leverage your investments in the stock market during times of market volatility (anxiety). Bottom fishing can turn out to be very expensive because you may be forced to liquidate positions at the bottom of the market.
Re-assess your asset allocation and rebalance your total investment portfolio to ensure that your risk budget reflects your risk appetite and duration or payback period (period to recover the current value of a total investment portfolio through income streams and payback of principal). Yes, reaffirm your investment product and review your expected portfolio returns.
Consider diversification to reduce overall stock market risk by shortening the duration of your total investment portfolio through an overweight exposure to developed market government bonds, adding assets such as gold, and lower beta investments such as private equity and hedge funds. Also, if needed, address the high concentration risk of the tech giants in the equity benchmarks, such as the S&P 500.
Hold a sufficient cash contingency reserve to provide for unexpected expenses, to avoid having to cash in investments during stock market routs.
Do not panic but also do not make rash decisions. Be flexible and rebalance your total investment portfolio more regularly as the markets unfold.
Keep enough power dry because opportunities may arise. At some stage, certainty will return to the market because of major trade deals and reduced geopolitical risk, resulting in stock markets resuming the long-term uptrend.
Market volatility can be navigated through unit cost averaging, whereby investments are spread over a period instead of made as single a lump sum. For example, if you are a regular investor in the stock market through, say, monthly investments in collective investment products, continue to do so because you will end up buying more shares or units when the prices are low and fewer shares or when the prices are high.
Yes, be prepared. The world and financial markets have entered uncharted territory.
Ryk de Klerk is an independent investment analyst.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute investment or financial planning advice that is appropriate for every individual’s needs and circumstances.
Baie inseggewend