Trump’s announcements of tariffs on steel and aluminium have led to a much greater focus on the risks posed by his presidency
We have had a rollercoaster start to 2018. January saw a rapid rise in global equities before markets succumbed to a technically driven sell-off, recovered a little, and sold off again on the announcement of US tariffs and concerns over the technology sector.
While equity markets are broadly where they started the year, investors are markedly less bullish, with the first signs of a slowdown in the global economy appearing.
Growth remains strong overall but it is the change in growth that matters for investors, and a slowdown could be a significant headwind to equities.
The moderation in growth so far has been most marked in Europe and Japan, with these economies typically more sensitive to changes in global conditions. However, consumers across the world also appear sluggish, with retail sales data disappointing in the US and UK, and consumer confidence coming off its highs across other major economies.
That picture seems unlikely to get any better as interest rates rise across the world and higher oil prices push up inflation.
That said, it is the pricing of risk that reveals the most important change in markets. In 2017, investors focused mainly on the positive elements of US President Trump’s agenda: tax reform and the repeal of regulation. But Trump’s announcements of tariffs on steel and aluminium have led to a much greater focus on the risks posed by his presidency, including his hard-line stance on issues such as Iran and North Korea.
The Trump effect
Trump seems inclined to give markets plenty to focus on. The President has to renew the waiver on Iranian sanctions before 12 May, for example – something he promises not to do unless there are significant changes to the current deal on Iran’s nuclear programme.
While he might have previously been constrained by those surrounding him in the White House, his recent appointees (such as John Bolton to the post of National Security Adviser) enable his more hawkish instincts. Bolton is famously said to have never met a war he did not like. Perhaps most importantly, though, he understands how to draw on and use the full resources of the US government.
A renewal of sanctions against Iran would provide further support to the oil price, with Brent crude having already managed to reach $70 a barrel this year. If that price level is sustained for the remainder of 2018, we could see inflation exceeding 3 per cent in the US, and at target in the eurozone.
That would hurt an already sluggish consumer and potentially lead central banks to tighten monetary policy faster than expected.
While oil price sceptics would argue that increased US shale production can compensate for global supply issues, the oil price has not reflected those predictions over the past six months. We have moved through $50 a barrel, $60 and now are threatening $70. It is possible we see a geopolitical risk premium being built into the oil price over the coming months, reflecting the perceived dangers around oil supply, even if these do not materialise.
Ultimately, it seems like markets are at a turning point in how they view the world. Bulls, rather than bears, will have to justify their views going forward and the normal flow of news will provide cover to those of a more pessimistic bent.
There is evidence some investors are now moving out of equities, with the net exposure of long/short equity funds at an 18-month low and other quantitative strategies reducing their equity allocations.
To my mind, this all argues for being neutral on risk, and adding some defensive exposure to portfolios. We are likely to see mini-cycles in equity markets, with periods of risk-on and risk-off behaviour.
Investors may want to use these episodes as an opportunity to sell on strength, gradually de-risking into the late cycle.
Bill McQuaker is portfolio manager of Fidelity Multi Asset Open Funds