Fear of Global Recession Unraveling Markets

The rise of nationalism has created a world more divided than many could have imagined three years ago when Trump took office. The ensuing inward-looking policies have resulted in antagonistic trade policies – arguing over everything from electronics to soybeans. Against this backdrop, the global economy is becoming ever more fragile, with slowing growth appearing in Europe, Asia, and, latest data shows, North America now too.

Fallout from the trade war

US and Canadian farmers, in particular, are feeling the pain of the global trade war, which is tough given that they were set to have a bumper year with higher prices prevailing. The biggest blow to the industry has been China’s decision to put a halt on all US agricultural imports after Trump announced a surprise $300 billion tariffs on Chinese consumer goods and electronics.

The agricultural goods hardest hit by trade have been US soybeans and canola, which the Chinese have traditionally imported from North America in great quantities. Due to the trade standoff, China has now begun to source soybeans from Brazil.

Given the globally interconnected nature of the agricultural industry, other commodities and agricultural industries in other countries have also been swept up in the trade-related volatility in prices and shifts in global demand. Canada’s pork industry has been adversely affected by China’s decision to block the country’s pork exports.

A multitude of industries are being adversely affected. A good leading indicator of trade trends, the world’s largest container shipping company, Maersk, recently warned that growth in global trade was being impacted by the US-China trade war. It predicted that trade restrictions could reduce container trade by up to 1% once the $300bn tariffs have all been implemented.

Meanwhile, there is some speculation that China may be settling in for the long haul; waiting for a new US President to come in. Both sides have their own reasons for not wanting to back down but they also face economies that are slowing – and there’s the risk that recession could set in should the trade wars continue. In the US, the latest IHS Markit Purchasing Managers’ Index (PMI) slipped below 50 in August, signalling the US economy has joined most developed economies in contractionary territory, while Chinese Industrial Production fell below 6% for the first time in 17 years in July.

Chinese and American businesses want this trade war to be over. US business associations implored Trump to lift the tariffs, to which he responded saying they were badly run and making excuses. China has the advantage of being a controlled economy with a long-term plan, while the Americans have the world’s largest economy. However, the US also has a democratic electoral process that could see Trump out of office. As all of this plays out, the global economy will likely slow down.

The million-dollar question is: Could the next US President inherit this trade war or is there any possibility of a resolution before the election? Whether the next President assumes office after the 2020 election or the 2024 election, it is likely that the fall out from these Trump- instigated trade wars will create a mess that the next US president has to clean up. Of course, the sooner Trump is out of office, the more expeditious this process will be.

Federal Reserve chairman Jerome Powell has also come into Trump’s firing line. Trump has repeatedly accused Powell of holding back the US economy by not being more aggressively accommodative. However, he is terribly misguided in his view that it is the Fed, rather than his trade war, that is the source of market uncertainty and lacklustre economic activity.

Powell has held firm in the face of Trump’s bullying tactics, making it clear that monetary policy alone could not reverse the damage the trade war is doing to the US and global economy. In his speech after the Jackson Hole central bank symposium, Powell spelled out the Fed’s stance: “We have much experience in addressing typical macroeconomic developments. But fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed.”

Trump responded by tweeting: “…My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” In another tweet, with China the target this time, Trump threatened to invoke the Emergency Economic Powers Act of 1977, which is ridiculous. But absurdity has become commonplace with this administration. Ordering American companies to stop doing business in China is not going to fly and could well impede Trump’s re-election campaign.

Investors voted with their feet after he tweeted this command, with the Dow Jones Industrial Average sliding 900 points in response, and the S&P 500 and Nasdaq falling in tandem.

Monetary policy context

In Europe, central bankers are experiencing pressures of a different nature. The Eurozone economy is weak and there’s consensus that the European Central Bank needs to introduce another stimulatory package at its September 12 meeting. Mario Draghi laid the groundwork for this at the last meeting, indicating that the Bank was considering a parcel of measures, including, perhaps, a tiered interest rate structure to alleviate the strain low interest rates are putting on bank profits.

Given concerns about the softening economy, some central banks have resorted to a zero interest rate policy (ZIRP) in order to encourage spending and investing and prevent their economies from stagnating. Cutting interest rates to zero, however, might not be enough to spark the economy if deflationary pressures are severe. In such cases, central banks might pursue a relatively new path, with a negative interest rates policy (NIRP). This should discourage investors from hoarding their money in the bank, given that they’ll have to pay to keep it in there. In turn, this super loose monetary policy, it is believed, should encourage spending and investing.

Ultimately these types of monetary policy (zero interest rates and negative interest rates) will make it tougher for banks to generate profits and maintain strong balance sheets, which puts the global banking system, which is already under pressure, in an even more precarious situation. Lagarde has said the ECB will be monitoring the banking sector and financial sector closely.

Negative interest rates have prompted some unprecedented moves. In the Nordic countries, for instance, Denmark’s third largest bank, the Jyske Bank A/S, became the first bank to pay customers to take out a mortgage, charging them -0.5% interest on 10-year mortgages.

In the UK, the economic outlook remains highly uncertain. Boris Johnson hit the ground running after he took over as Prime Minister, determined to bulldoze Parliament into a no-deal Brexit if the EU refused to renegotiate and exit package. He was met with huge resistance when MPs voted to seize control of the Commons agenda in an effort to block a no-deal Brexit. The pound experienced a relief rally from its 34 year low in response.

Brexit is also likely to determine the nature of Canada-UK trade negotiations. Both countries have been in discussions around a bilateral trade deal but Canada put a halt to this until Brexit has been resolved, with the government believing Canada may be in a position to secure a better deal.

Restoring Unity in a Divided World

We believe policy makers and citizens will become exhausted from all the high drama going on in the developed world and that a return to a more civilized world will create opportunities for global investors. However, things could well get worse before they get better and we can’t predict with any accuracy exactly how the situation could unravel. But events this year have set the stage for anything possible to happen and the investing landscape is likely to be affected negatively. And with Trump free to express his thoughts to the world on a whim, we expect to see more volatility during the months ahead.

As always, however, we maintain our disciplined value investing philosophy where we seek out companies that are positioned to weather the current financial and political storms and that offer potential based on their long-term intrinsic value.

Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca