Markets have normalised Trump’s behaviour – which means they don’t realise the risks
Nicholas Spiro says the president’s unusual behaviour on trade, alliances and North Korea do not appear to be making investors more hesitant. This could be the result of his tax cuts, but could also be due to desensitisation, leading them to not appreciate the danger
Financial markets’ perception of US President Donald Trump is becoming more perplexing by the day. Over the past few weeks, Trump has ignited a trade dispute with long-standing allies of the United States in Europe and Japan, lashed out at the prime minister of Canada and, according to most foreign policy experts, made dangerous concessions to North Korean leader Kim Jong-un at Tuesday’s US-North Korea summit in return for a vague commitment to dismantle Pyongyang’s nuclear programme. Yet markets’ reaction to these worrying developments has been one of indifference.
On Tuesday, the benchmark S&P 500 equity index even rose modestly, taking its gains since the end of May to more than 3 per cent. Perhaps more surprisingly, the Kospi, its South Korean equivalent, barely budged and is up nearly 2.5 per cent since the end of last month. Meanwhile, the VIX Index, frequently referred to as Wall Street’s “fear gauge”, which rose sharply during the recent sell-off in Italy’s bond market, currently stands just above its lowest level on record.
How is it possible that markets can shrug off events as momentous as the crumbling of the rules-based system of international trade and a US-North Korea summit outcome that is being portrayed as a victory for one of the world’s most notorious despots?
The simplest explanation is that international summits have never been uppermost in investors’ minds, mainly because they are derided as talking shops. More generally, investors have a long track record of downplaying political and geopolitical risks on the basis that they are difficult to price and invariably do not pose a systemic threat to the global economy. This is particularly the case at a time when monetary policy remains exceptionally loose, desensitising investors to vulnerabilities in the world economy.
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Yet there is another, more troubling, explanation which would have been unthinkable before Trump’s upset victory in the 2016 presidential election: markets have grown accustomed to Trump being Trump.
Just as investors always knew that candidate Trump had a penchant for off-the-cuff and derogatory remarks, they now know that President Trump acts the same and have learned to take no notice of his outbursts and emotionally charged tweets on the grounds that the US economy is performing well. Indeed, the more Trump hurls abuse at foreign leaders and thumbs his nose at the liberal order, the less markets pay attention.
Make no mistake, the populist insurgent who at the time of his election to the most powerful office in the world was deemed to be the leader least likely to breed complacency in markets is now doing just that.
While there have been signs that the turmoil at the White House and the administration’s increasingly protectionist policies have undermined sentiment towards US assets – last year’s nearly 10 per cent decline in the dollar index, a gauge of the greenback’s performance versus other major currencies, was partly attributable to a loss of confidence in Trump’s pro-growth policies – the sharp falls in the S&P 500 this year have had more to do with the resumption of volatility and the strain on technology stocks.
Trump the bully and protectionist has also been offset in the minds of investors by Trump the tax-cutter.
The administration’s cut in the corporate tax rate from 35 per cent to 21 per cent, enacted last December, has helped buoy corporate earnings and improve the outlook for the US economy at a time when there are mounting concerns about global growth, particularly in Europe. While Citigroup’s Economic Surprise Index – a closely watched gauge of the extent to which incoming data exceeds or falls short of analysts’ expectations – for the euro zone has collapsed this year, it still remains in positive territory for the US.
According to the latest global fund manager survey published by Bank of America Merrill Lynch on Tuesday, investors have suddenly become extremely bullish on US equities, with respondents’ favourable outlook for corporate profits surging to its highest level in 17 years. The threat of a trade war, moreover, is now deemed to pose less of a risk than a policy mistake by the Federal Reserve or the European Central Bank, the survey notes.
Still, the fact Trump’s economic nationalism and contempt for America’s allies are having such a muted impact on markets is deeply troubling and shows the extent to which investors are underpricing risks to the global economy.
While markets can be forgiven for not correctly predicting the policies of central banks, Trump showed his hand a long time before he became president.
Nicholas Spiro is a partner at Lauressa Advisory