Trumpoline time?

“I've had nightmares that made more sense than this.” (Lazar Kaganovich, The Death of Stalin)

Investors feeling baffled by the moment can take reassurance – this suggests only that you are sane. President Trump’s necessarily hurried lunge for legacy continues to evolve hourly, often leaving fans and foes alike scrabbling for ex-post justification.

As we’ve suggested before, perhaps this is a deliberate ploy – a poker player keeping their opponent off-balance to glean a negotiating advantage. Or perhaps not. What we can now say with a little more confidence is that the main intended audience for all this bluff, bluster and ‘madman’ trade protectionism is China.

This week, we take a fresh look at the outlook for the world economy and her capital markets in amongst this assault on the post-war order.

The latest

As we have pointed out before, the world economy entered this high-stakes game of chicken in decent order. The US economy in particular was (and still is for now) motoring. There were even tentative signs of cyclical life in Europe, with the UK economy showing a recovering pulse on the latest read.

Some of this US pep can be explained by government spending, with persistent deficits larger than you might expect with unemployment so low. However, the overwhelming majority could be chalked up to a vibrant and dynamic private sector and a consumer enjoying both balance sheet strength and positive real income growth.

The central cog in that private sector vibrancy has centred around companies implementing the early fruits from this latest industrial revolution, helping to boost productivity growth¹ (Figure 1).

Figure 1: US productivity has increased in the latest business cycle

Source: Datastream, Barclays

As it goes, China and Germany were two of the economies limping most visibly relative to their potential. Already, the more abrasive posture from this new US administration has helped to prise the German government’s wallet wide open, with potentially epoque-defining implications for the wider euro project. This is particularly the case with the US now more openly sceptical² of the rewards to global leadership.

The still unanswered question is whether China can be coerced into a similarly seismic change. Trade-ending tariffs are now in place between the US and China. Chinese policymakers do have a case to answer – Chinese workers remain underpaid and supported relative to their output, which has contributed to giant global imbalances of demand and supply. There appear to be some moves in the right direction, but whether these efforts will amount to a long-awaited and necessary rebalancing of China’s economy is unclear.

Incoherence as a strategy

We’ve written before about the questionable merits of a madman approach in negotiating strategy. This is particularly the case in the fiendishly complex worlds of international trade and relations, where the unintended consequences can ripple through the decades, ultimately overwhelming the intended (unlike in a game of poker).

Perhaps this (manufactured?) chaos becomes too convincing. Europe and China are indeed galvanised, but the blow to US institutional exceptionalism is sufficient to signal the beginning of a wider decline in appetite to lend (in various forms) to the US. Meanwhile, the societally regressive switch to tariffs over income taxes furthers already historic levels of inequality (of income, wealth and opportunity), creating the political space for messier politics still.

What next?

The darker paths ahead are ever easier to imagine in moments such as these – should we seriously contemplate a US default?³ Where and how does the Federal Reserve step in if the situation becomes more disorderly, particularly if inflation and inflation expectations are on the rise at the same time?

Moreover, it took two years to negotiate some ultimately minor changes to NAFTA⁴ in President Trump’s first term. We should therefore be sceptical of what can be meaningfully achieved in close to a hundred bilateral trade negotiations before the 90-day ‘pause’ expires. We can also assume that sectoral tariffs are coming, with pharmaceuticals first in the queue – it is perfectly possible that we are not yet at peak tariff uncertainty.

Meanwhile, corporate earnings, and more importantly updated outlooks, continue to roll in. Further responses brew in Europe and elsewhere, with the latest industrial revolution providing mostly invisible but likely definitive long-term investment context.

At times like this, there is work to be done for investors. Thinking through plausible extremes, both positive and negative, can be helpful in framing investment decisions. The important piece, as our internal behavioural specialists regularly warn, is to keep emotions and biases in check. The tendency for our political and other persuasions to quietly shape the weights we assign to the myriad potential paths ahead is obviously to be avoided.

The north star for investors remains the degree to which incoming technologies and those yet undreamt of will continue to confer added superpowers on our species. We should feel optimistic on that front, even if the short term looks a little less reliable. Try to keep your eyes above the melee on the medium term. As a species, we are much more than a sour glance at your social media feed might suggest.⁵