GMO: “A Global Trade War Would Lead To A 40% Market Crash”

If one was following the price action of stocks today in response to Trump’s Thursday announcement of steel and aluminum import tariffs, one would be left with the impression that either the market thinks Trumps is bluffing, or that tariffs are bullish for risk assets. As shown in the chart below, both the S&P and the Nasdaq closed at session highs, with the Dow just barely red, while the tech index was effectively unchanged from yesterday’s announcement level.

Well, considering that Trump not only doubled-down, but tripled-down  on his tariff threats, it does not seem realistic that the president will flip-flop on this issue, even if it means that Trump’s precious stock market (big, fat bubble) lets out some air.

Which then leaves open the question of whether tariffs are – somehow – bullish. And just to dispel any confusion on the topic, this afternoon GMO’s Ben Inker wrote something so simple, even a momentum-chasing algo will understand it:

As a general rule, when you add “war” to your description of an event, it’s a pretty strong suggestion that it is unlikely to be either good or easy. Wars are sometimes well intentioned (the war on drugs), occasionally necessary (World War II), but seldom good and more or less never easy to win.

The last of course is a doubled-downthat “trade wars are good, and easy to win” to which Inker responds that “even if you do “win” easily, the longer term implications are often more problematic than you thought (the second Iraq War). There is still some time for this particular war to be averted. But while it is our general contention that equity markets tend to overreact to political and economic events, this is not one of those times.”

So assuming global trade war breaks out, what is the worst case scenario? Here the GMO strategist is about as “doom and gloomy” as Paul Tudor Jones was yesterday:

While there are scenarios that would be worse for financial markets—the proverbial asteroid on a collision path with Earth comes to mind—a trade war has the potential to be very bad for both the global economy and investor portfolios. As I wrote about last December, a significant inflation problem might well be the worst thing that could happen to a balanced portfolio, leading to losses on the order of 40%. A global trade war would be exactly the kind of economic event that could foreseeably lead to losses of that magnitude.

Of course, a 40% drop in the S&P is just the start of what has to happen for risk assets to be priced relatively fairly in a world in which central banks no longer are propping up risk each and every day. And the best case – if only for the Fed – is that the entire crash would be blamed on Trump’s policies, allowing the entire FOMC to sneak through the back door and completely avoid the pitchfork-armed crowds who for the third time this century will wonder where their unbooked profits vaporized to.

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Ben Inker’s full note is below (pdf link).

Trade Wars are Bad, and Nobody Wins

Yesterday’s announcement by President Trump of imminent tariffs on steel and aluminum imports was taken poorly by global stock markets. Perhaps in an attempt to convince investors this was an incorrect response, early this morning he tweeted that “trade wars are good, and easy to win.” He is wrong, and beyond the simple fact of his wrongness, a trade war is probably more dangerous for investors at this time than at any other time in recent history given the implications it would have for inflation, monetary policy, and economic growth. The only positive from the tariffs is that it is a windfall profit increase for U.S. producers of steel and aluminum, which is at least positive for them. It is unlikely to cause any material increase in U.S. capacity to produce steel and aluminum and therefore unlikely to lead to many additional jobs even in those sectors. The negatives are much more significant. I believe these tariffs on their own will push inflation higher, and higher inflation is a threat to the valuations of more or less all financial assets today. But the greater threat is that this escalates into an actual trade war. A trade war would increase prices on a much broader array of goods and services, while simultaneously depressing aggregate global demand. This pushes us in the direction of not just inflation but stagflation, where both valuations and corporate cash flow would be under pressure. While there are scenarios that would be worse for financial markets—the proverbial asteroid on a collision path with Earth comes to mind—a trade war has the potential to be very bad for both the global economy and investor portfolios.