Fidelity Insights: by Tom Stevenson, Investment Director
A couple of weeks ago, I suggested that 2018 would be the year in which we waved goodbye to Goldilocks. By that, I meant that the unusually favourable conditions investors enjoyed in 2017 – solid growth, lower for longer interest rates, subdued inflation and a lack of volatility – could not be expected to continue this year.
At the time, my concerns were largely focused on inflation and interest rates. The first market wobble of the year in February had been triggered by higher than expected wage growth in America and the fear that this would lead to more rapid monetary tightening than was then being priced in by investors. The risk to the Goldilocks narrative a couple of weeks ago was that the economic porridge was ‘too hot’ rather than ‘too cold’.
As it happens, new Fed chair Jay Powell’s first press conference last week ended up conveying almost the opposite message (possibly also the opposite of what the rookie chairman intended) and markets have gone back to their old habit of taking the US central bank’s rate forecasts with a pinch of salt. Investors have moved on from worrying about inflation and interest rates and are now much more concerned about the growth part of the equation. Goldilocks’ breakfast now looks a bit ‘too cold’.
The year’s second market wobble, at the end of last week, was therefore all about growth fears. Some of these are real, in the form of declining manufacturing orders in Germany. The potentially more important ones remain in the future and are still therefore speculative. These reflect a dramatic escalation in the rhetoric from both the White House and Beijing over trade.
The imposition of up to $60bn of punitive tariffs on Chinese exports to the US was immediately followed by an apparently much smaller retaliation from China. But Beijing left no doubt about its intentions when it said that tariffs on $3bn of US imports were a like-for-like response to Trump’s previously announced steel and aluminium levies. The door was, therefore, left wide open to a subsequent tit-for-tat response to last week’s more significant provocation.
President Trump is quite wrong to suggest that he can win a trade war. History suggests that protectionism delivers only losers on all sides. It is bad economics and bad politics too. Protecting a few steel manufacturing jobs at the expense of many more in steel-consuming industries like motor manufacture is senseless. As is the imposition of a set of tariffs that was so poorly targeted that it has already had to be hedged around with exemptions for a wide range of countries from Canada to Europe and South Korea.
Even this clumsy back-pedalling has been mishandled by the Trump administration. Perhaps the decision to exclude Japan from the list of exempt countries is a deliberate negotiating ploy, but Prime Minister Abe must be wondering why he bothered with that gold golf club for the President. With friends like him, who needs enemies?
The market reaction to the rise in trade tensions was discriminating but heavy-handed. Japan was hit hardest for good reason. Of all the major economies in the world, it is one of the most dependent on global trade. Its currency is also a safe haven at times of stress and at 104 yen to the dollar, Japanese exports are less competitive than they have been for some time. Germany, too, was rightly in the cross-hairs; with exports representing around 45pc of economic output, it is more vulnerable than most to the threat of a damaging trade war.
Ironically, until the recent escalation in trade tensions, both Europe and Japan were among my most favoured equity markets. Japan, in particular, is finally getting to grips with a generation of deflation, its jobless rate is lower than at any point since the 1980s boom and corporate earnings are growing strongly. Japanese shares are no more expensive, measured against profits, than they were five years ago.
All of which makes it doubly important to divine whether Mr Trump’s bark is worse than his bite here. If there is more posturing and rhetoric than real substance, and if China recognises this and responds in a measured way, then like the earlier inflation and interest rate scare the trade war concerns might also blow over. As ever, real market problems tend to emerge from left field – the increasing absence of calm voices around the President seems to me a much more significant concern right now.
But, that said, two significant market tremors in as many months represents a wholly different environment from last year’s Goldilocks landscape in which Thursday’s 2.5pc fall in the S&P 500 or the Japanese market’s more than 4pc slide would have been unthinkable.
Although completely unrelated to the trade row, Facebook’s woes last week confirmed that when confidence becomes frayed there is rarely just one loose thread to tug on. The common theme here is trust. Facebook seems to have played fast and loose with the trust of its users. The whole tech sector’s valuations are dependent on investors’ trust in the sustainability of their earnings in the face of a less forgiving regulatory environment. The global system of trade hangs on the trust that the rules will not be arbitrarily changed. None of these can now be relied on.
This is not the moment to be a hero with your investments. Balance, diversification and uncorrelated assets are key. Living to fight another day has much to commend it as an investment strategy when Goldilocks has packed her bags and gone home.