March Madness in the US refers to a popular national college basketball tournament. This year you might apply that nickname to the harsh trade policies emanating from the US White House.
President Donald Trump’s attack on its trade partners on April 2 knocked world stock prices into a funk and caused investors to scurry towards safe haven assets such as government bonds and gold.
By mid-afternoon on Friday, the Trump White House’s tariff announcements had helped wipe off roughly $4.9tn of value from world equity markets, according to Dan Coatsworth, investment analyst at AJ Bell.
All that volatility is squeezing most people’s personal portfolios and pension pots. Even worse, a sharp drop in the dollar after the tariff announcement has caused sterling or euro-based investors extra pain.
“Market downturns and heightened volatility can be unsettling, particularly when headlines amplify uncertainty,” says Myron Jobson, senior personal finance analyst at retail platform Interactive Investor. But he says investors should “resist the urge to make knee jerk reactions”, which can “lock in losses and derail well-laid investment plans”.
$4.9tnApproximate loss from world equity markets since the tariff announcements
On Interactive Investor’s platform, many traders in the UK have been buying the dip — Nvidia was the most traded investment this week, with 74 per cent buying the stock and 26 per cent selling. In second and third place respectively were UK-based engine maker Rolls-Royce (57 per cent buys) and Barclays (73 per cent buys).
FT readers might rightly ask whether the time has arrived to add to their own equity portfolios.
But instead of the answer, start with the question. Catching the end of any collapse in share prices requires the keen sight and speed of a famished falcon. Ask whether now is a good time to begin accumulating shares or not, spreading purchases over a period of time to mitigate the risk of further losses. What signals might point to a turn in sentiment?
Given the high correlation of many international stock markets with that of America, and since most of the catalysts have come from there, focusing on the US markets makes some sense.
When bad news is good. Markets often follow narratives, negative or positive. So noting when securities prices do not react as expected to a strong earnings announcement — or worse than expected inflation data — can offer clues to the market’s mood.
Currently the mood is clearly poor. No one has a clear idea of how any rises in import prices in a tariff war would percolate through to consumers. But some economists have produced some disconcerting figures on the effect.
On Wednesday, the White House announced new import tariffs covering more than 100 countries and territories. These percentages ranged from 10 per cent for quite a few countries including the UK, up to 49 per cent for Cambodia. China received an additional 34 per cent tariff rate above existing ones, while the EU was hit with a 20 per cent rate.
A full-blown trade war, ending with 25 per cent import barriers from every US trading partner, would produce a $1.4tn hit to the world economy, including a 2.5 per cent reduction in US real income per capita, according to estimates by economists at the UK’s Aston University made prior to the tariff announcement.
But investing is as much about psychology as fundamentals. Yes, grasping all the important stuff, such as corporate earnings growth, price inflation and consumer spending behaviour, are vital to divining the future direction of equity markets.
In the Oliver Stone film Wall Street, Lou Mannheim, the grizzled veteran, advises the very green Bud Fox to “stick to the fundamentals” as most investors would have done. In the end, Fox doesn’t follow the crowd and the rest is film history.
No one is suggesting that crime offers a better investment strategy, but understanding how the bulk of investors have positioned themselves, what they own versus what they lack, is helpful to know. You might then want to move in the opposite direction.
Many professional investors claim to subscribe to just such a contrarian viewpoint, but few really practice it. And there’s a good reason for this: it’s risky and difficult to defend a contrary view to your bosses or clients, especially if the strategy later loses money.
Make no mistake, though, the tone from the asset allocators at some of the largest investment institutions has clearly turned more negative. That is a trend shift in itself.
“Diversification is your friend. More cash, not bonds. Stagflation is a risk here, not just recession,” says Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International. “If all the [US trade] tariffs come through as discussed they will deliver a [1.8 percentage point] inflation shock to the US,” based on Fidelity estimates.
Some have only recently changed their views. Consider this statement from the UK’s sensible, and formerly optimistic, CCLA — Churches, Charities and Local Authorities, which invests nearly £16bn for its clients. “We reduced equity exposure by 5 percentage points in our multi-asset funds last month, raising index-linked gilts and cash. We had not wanted to pre-position cautiously ahead of a trade war that might not happen, but now believe a trade war has started.”
But what are the signals that prompted a change in view? While markets have clearly underestimated Donald Trump’s zeal for raising US trade barriers, some warning signals have flashed amber, if not red, for years before Trump 2.0.
Mostly, this worry focused on the US given its size relative to others. For example, historically high US stock price valuations relative to earnings have dwarfed those in other countries and have long been a talking point.
There are many others. One is the value of equities among the financial assets of US households. This amount, according to data from Bank of America and the Federal Reserve, has swung between 10 and 30 per cent since the second world war. By the end of last year the proportion had reached 29 per cent.
This might bring pause for thought. Not only has this percentage risen well past that at the top of the first tech bubble, which popped in 2000, but that figure also exceeds the previous peak of 28 per cent in 1968.
To get back to the low end of the historical range, not even its nadir, would require equities to halve in proportion. The omens are not good. Stocks did do very poorly in the 1970s and in the 2010s after topping out.
But the clarity of hindsight is not in dispute. After a difficult three months for US shares, and with pessimism intensifying, some will rightly wonder if at least a short-term reversal might lay ahead next quarter.
One place to look for hints of this is among options, those derivatives, which can be converted into their underlying securities, say stocks and shares, at a strike price by a given date. Options allow one to profit from changes in share prices, up or down, with relatively little capital outlay.
While the options market is nothing new, their popularity among retail and professional investors, especially in the US, has grown in recent years. Highly sensitive and fluctuating option prices can give signals about investor intentions.
But you don’t need to buy these products yourself for them to be useful: they can be a telling measure of sentiment. One way is to track the volume of trade of puts as a ratio of the same measure in call options, the put/call ratio.
A surge in put volumes versus calls hints at bearishness, and vice versa for call options. This ratio over time has swung around a mean.
When this indicator reaches an extreme above or below this mean, market observers take note. Late last week, the put call ratio was firmly in neutral territory, stuck in the middle of its long-term historical range.
More sophisticated measures track how expensive puts are relative to calls, known as skew. More demand for puts, which are often used for hedging, should result in pricier puts than calls. Lots of investors paying a high premium for puts should give a sense of problems ahead, and the reverse if puts seem relatively cheap. The CBOE Skew index was historically high through October into January, providing an early warning of the downturn this year.
Alas, the Skew Index too sits roughly in the middle of its range, offering little sense of extreme bearishness or bullishness for the months ahead. As yet there is little to indicate the kind of intense bearishness or irrationality that might give a contrarian some hope. That fact alone suggests that this bearish phase has probably not ended.
By the time of so-called liberation day, the exact tariff percentages were not the issue. Traders had priced in much of that bad news, but whether they have fully anticipated the fallout is not clear. “I think the market [was] more prepared for tariff risk . . . it [has] under-positioned for the recession risk,” thinks Emmanuel Cau, Barclays’ head of European equity strategy.
As such, the thesis that “US exceptionalism” will continue with the America First policy from the Trump White House will be tested, thinks Cau.
If there is one signal to watch for the rest of the year it is inflationary expectations. Widely followed surveys in the US, such as New York Federal Reserve’s Consumer Survey of inflation expectations one year ahead, have jumped from under 3 per cent to more than 4 per cent since late last year.
More importantly, the implied inflation rate from US two-year inflation protected bonds (TIPS) have climbed steadily since September. Until this indicator reverses, or at least levels off, markets will remain nervous.
This is bad news for equity prices. Price inflation creates a political problem for any government, but especially one for President Trump, who promised to control this. Persistent inflation also puts a dent in hopes that the US Federal Reserve will lower interest rates soon.
A trade war will only keep upward pressure on inflation expectations, and that is definitely not a good sign of things to come.
Additional reporting by Jamie John
