I don’t know whether Liberation Day was the correct name to be given to this past Wednesday, but D-Day appears to be pretty fitting for Thursday. Whatever thought process was going through the minds of Trump and his economic advisors, it wasn’t based in accepted economic theory, and judging by the huge vote of non-confidence handed down by global equity investors, it wasn’t based on market theory either.

 

The decision to impose sweeping and heavy tariffs against America’s trading partners has led to condemnation by most analysts and economists, with only a handful still sticking with the “tariffs might be good this time” playbook. One in that minority appeared Wednesday on Bloomberg, drawing a comparison between Trump’s tariffs and a cardiology drug comprised of warfarin sodium (or rat poison). While poison is generally bad for you, this drug does save lives. True, but the problem with this comparison is that we ran multiple clinical trials on this drug before it was widely prescribed to patients. There are no such trials for Trump’s tariff barrage and for similar attempts made in the past, the trials only saw the economy in question flat line.

 

 

 

It is hard to imagine that no one in the White House believed equity investors would be happy with the tariff announcement. Nevertheless, the stock vigilantes have come out in full force in response to the tariffs, but also the announced retaliation by China overnight. By 10am this morning, the S&P500 was down a further 3.5% after the sharp sell-off Thursday, and the NASDAQ was down 3%, bringing year-to-date losses for both to 11.6% and 16.7%, respectively. Other markets have suffered smaller, yet still substantial hits, with the TSX down 3.2% today and the Euro Stoxx 50 off more than 3.8% this morning. London’s FTSE had seen only minimal damage Thursday but has shed 4% today.

 

On the commodity front, the inference that these tariffs would increase the probability of a global recession, has resulted in some fairly large retracements. Crude oil futures are down more than 5% this morning to below US$65 per barrel, adding to losses on Thursday. Note, yesterday’s decline was partly attributed to the announcement by OPEC+ that will accelerate production increases and raise output by 411,000 barrels per day come May. Copper futures have dropped by 3.8% this morning and aluminum is off 1.3%.  Even gold as started to fade, losing 2% this morning, as the U.S. dollar comes under pressure.

 

 

 

As investors pulled risk off the table, they piled into bonds, sending the 2-year U.S. treasury yield to 3.5% this morning – the lowest since last September, while the 10-year yield has rallied down to 3.9%. Here in the Great White North, the 2-year yield has pushed down below 2.3% for the first time in three years, and the 10-year yield has resumed its decline after a temporary push higher on Thursday. Despite the improved flows into bonds, investors haven’t really altered their expectations for what central banks will do in the wake of Trump’s tariff fit. Looking at fed funds futures, there is only a partially implied cut of a quarter point at the May FOMC meeting and the same holds true for the Bank of Canada.

 

 

 

 

For quite a while now we have heard market participants refer to the U.S. as “exceptional”, highlighting that equity market valuations could remain high despite things like the higher interest rate environment of the past couple of years and policy volatility coming out of the White House. Foreign investors would still prefer U.S. investments over others, and this would not only support stocks, but also the U.S. dollar. Well, that view is being turned on its side as the U.S. implements isolationist policies that won’t necessarily promote stronger growth or productivity. Countries are also not rolling over as Trump may have desired. Canada is going ahead with counter measures against U.S. vehicles that are not compliant with the U.S-Mexico-Canada free trade deal that Trump pushed for in his first term and these are in addition to the initial $30 billion in retaliatory tariffs announced under then PM Trudeau and the 25% counter tariffs on U.S. steel and aluminum. China waited until last night before announcing a sizable 34% retaliatory tariff on U.S. goods, ramping up the threat of a wider global trade war. As for the European Union, they have indicated that a response is being prepared.

 

From this, countries are poised to create economic allegiances and strengthen those already in place. That applies to Canada, but also Europe and Asia. In fact, the heaviest hit by Trump’s tariffs region has been Asia and this could work against the U.S. in terms of its policy of slowing China’s dominance in Asia, Africa and even Latin America. One recent example of this was the inflow of Chinese aid and support into Myanmar following last week’s devastating earthquake. With the foreign aid departments in the U.S. government being dismantled, it has pledged only a couple of million dollars in aid, compared to almost $14 million from China.

 

 

The fact that the U.S. runs an extremely large trade deficit with the rest of the world is not up for question, but it does so because it imports products that are produced at a lower cost than what can be done in the U.S. For all Trump’s talk of bringing manufacturing home, the reality is that a Nike sneaker would cost significantly more to consumers if it were made at home. To run such a deficit, however, in addition to an uncontrolled fiscal deficit, the U.S. does consume a ton of capital. The supply of that capital from abroad is dependent on foreign investors willing to take on the credit risk of the U.S. Normally, this isn’t an issue, but again the view is changing.

 

 

 

One of the striking features since Trump took office is how the American greenback has behaved, as shown in the above chart. The U.S. dollar index (DXY) tumbled to close to 102 on Thursday – down from a pre-inauguration high of 110. Key support is just a couple of points away and a break could signal a further retreat back toward its pandemic lows. The dollar lost ground against most major currencies, including the Loonie, which has rallied to just above 71 US cents. This reverses all of the losses since early December. The euro, which was destined for a continued decline towards parity against the dollar, has now vaulted to above 1.10.

 

This shift away from U.S. assets could very well turn out to be temporary. The tariffs announced on Wednesday do not kick in until next week and because the emperor has a habit of changing his mind, who’s to say that some of the heaviest measures are retracted? On the same note, the economic damage to the U.S. is becoming more transparent to everyday Americans and this has Republican representatives in the House and Senate more concerned. The longer the tariffs remain in place, the more inescapable an economic downturn will become, which means a sharply higher U.S. unemployment rate. A logical politician might decide to change course before that happens, given that mid-term elections are only 18 months away. Then again, there wasn’t a lot of logic this Wednesday.

 

What this means for portfolio strategies is that we have a week to prepare two game plans. One is to position for a possible “change of mind” scenario and that is what most fund managers have been doing since inauguration day. The other plan is evacuation, should tariffs stick and retaliatory measures kick in, leading to an all-out trade war. In that event, the recession playbook suggests a lower equity exposure and short to medium-term bond overweight. It also calls for a major rethink in terms of where we want to deploy capital geographically.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

 

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The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc. Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.