After a month of tumult, investors in American stocks are making peace with the trade war. The S&P 500 index is down by just 2.4% since Donald Trump issued his “Liberation Day” proclamation. Stocks are still about 10% below their all-time high in February, when investors expected the administration to do little except cut regulations and taxes.
But they are not pricing in a recession, let alone a trade catastrophe. Analysts expect annual earnings growth of 12%; stocks are almost where they were before Mr. Trump was elected.
Investors are being too sanguine. The tariffs America and China continue to levy on each other are so high that they amount to a near-embargo between the world’s two biggest economies. Mr. Trump’s swingeing “reciprocal” levies on most of the rest of the world have been postponed, not cancelled. China’s export orders are down and bookings for container ships to America have plunged. Businesses say they are cutting investment and consumers are increasingly fearful of unemployment and inflation.
The argument for a market rebound rests on three ideas.
The first is that, notwithstanding an annualized contraction of 0.3% in the first quarter, official data have yet to register the economic slump suggested by surveys.
Second, markets now expect the Federal Reserve to cut interest rates by nearly a percentage point this year, which would boost growth and raise the discounted value of future profits.
Third, and most important, Mr. Trump’s commitment to protectionism always seems to crumble under pressure. The latest climb-down came on April, when he eased the 25% tariffs on cars and parts due to come into effect on May 3 by, for example, exempting cars from other duties.
These justifications for a recovery are brittle. It will take another month or so for America’s economy to feel the impact of reduced trade with China. Importers stockpiled goods in advance of the tariffs, and ships take weeks to travel from China to America, meaning that the effect of canceled shipments lags behind. If the shock does hit, it will severely disrupt goods supply chains and collapse demand for trade-related services such as haulage. Americans could see empty shelves.
Interest-rate cuts will not do much to prevent this. They can limit falls in consumer spending and investment, but they cannot mend supply chains or replace missing goods any more than they could stop Covid-19 lockdowns in 2020 or energy shortages in 2022. In fact, too much stimulus at a time of shortages would be harmful, because it could worsen their inflationary effects — as the pandemic showed.
The case for bullishness therefore rests on tariffs being lowered. Although Mr. Trump looks increasingly likely to back down in the face of market discipline and plunging approval ratings, it is hard to gauge his pain points.
On April 22 he boasted that he had already struck 200 trade deals, but there is little evidence for his claim. And even if he agrees to a big reversal, duties on China are unlikely to return to their previous level. America already has general tariffs of 10% and could end up by imposing something close to the 60% that Mr. Trump promised for China during the campaign. That would still be worse than many anticipated and cause severe disruptions to trade.
Not all investors are calm. The dollar has fallen more steeply than the stock market, and outflows from foreign-based American equity funds form part of a “buyers’ strike on US assets,” according to Barclays, a bank.
The strongest demand for stocks seems to be coming from retail investors in America, who like to “buy the dip.” Some of them could be allowing their investment in Mr. Trump at the ballot box to cloud their financial judgment. If their faith is to be rewarded, Mr. Trump’s climb-down will have to come soon.
