Please see below, an article from Tatton Investment Management analysing the key factors currently affecting global investment markets. Received this morning – 02/12/2024
Equities and bonds go separate ways
Markets tend to be quiet on the USA’s thanksgiving, but trading was a little frenetic last week. French politics hurt its stocks, while Trump tariffs hurt emerging markets. Japanese stocks were volatile – and moved reversely proportional to the yen. US bond yields fell thanks to Trump’s treasury secretary pick, Scott Bessent, whose “3-3-3” plan (covered below) is seen as a bullish for stocks and bonds.
Lower yields were accompanied by lower risk signals for US bonds – though inflation-adjusted numbers dropped too, suggesting investors are less convinced about growth plans. If inflation stays low, Fed rates should be accommodative, helping US private borrowers and the government debt load.
That rosy picture could help Europe. UK and European energy has consistently been around four times as expensive as the US and if that ratio remains, Trump’s plan to lower US energy prices could mean a four times larger price cut for Europe. That will be good for European growth even if the US puts up tariffs.
The main thing holding back positivity is politics. French Prime Minister Barnier just rescinded his electricity tax under pressure from Le Pen’s RN (who is facing embezzlement charges from the EU), which could derail attempts to bring down France’s unsustainable budget deficit. French yields remained relatively higher than other Eurozone governments.
The fundamental problem – in the UK, Europe and US – is tightening budgets without hurting jobs. It’s a hard problem made harder by governmental instability. Europe’s mainstream parties can’t form cohesive alliances, paving the way for populist parties to gain more influence next year – possibly in Germany and more likely in France. Investors don’t see upside for Europe, but there are seeds of (economic) positivity.
We note that bullish indicators have grown to unprecedented levels recently. While these can be concerning in terms of overconfidence, they aren’t great timing indicators. We remain cautiously optimistic, but we could see volatility if there’s bad news.
Terrifying Tariffs
Donald Trump promised to put 25% tariffs on goods from Canada and Mexico on his first day in office – largely because of the drug fentanyl coming across the border. Those tariffs would violate the USMCA trade deal Trump himself signed in 2020, and Mexican President Sheinbaum warned she would respond in kind, damaging jobs and inflation for both countries – though Canadian Prime Minister Trudeau was more conciliatory. Trump also threatened additional 10% tariffs on China, again citing fentanyl imports, but it’s unclear what that 10% is additional to.
Mexico and Canada are even more important to US trade than China, with the North American neighbours having bought $560bn or US exports last year. Trump’s idea is to replace foreign trade with domestic, but many goods and services aren’t easily replaceable. Many companies might not survive the sudden tariff imposition – even those in the US who are supposed to be the ‘winners’ from Trump’s policies.
There will probably be some unintended consequences – like a weaker Mexican economy incentivising more border crosses into the US. One consequence could be the rest of the world rethinking the largely unfettered access that big US tech companies have to most national markets. Many of them get the majority of their revenues from overseas, so a fight back on that front could end up removing a source of US economic outperformance over the last 15 years.
Ultimately, tariffs probably won’t play out as Trump threatens. His statements read more like “The Art of The Deal” than a manifesto, particularly with regards to fentanyl imports. Trump’s pick for Treasury Secretary said as much before the election. The danger is that the tariff lever gets pulled too hard too often, but for now we shouldn’t get too worried. We remember the principle that worked well in Trump’s first term: take him seriously but not literally.
New US Treasury’s target of threes
Trump’s Treasury Secretary pick, Scott Bessent, has a “3-3-3” plan: cut the budget deficit to 3% of GDP, boost growth to 3% and increase energy production by the equivalent of 3mn oil barrels per day. He was supposedly inspired by Shinzo Abe’s “three arrows” (fiscal stimulus, monetary stimulus, structural reform) but his fiscal plans are the opposite and the Fed remains independent.
Bessent wants to lower oil prices while increasing US oil production, but those forces work against each other. That’s why he talks about “equivalents”, but nuclear energy, for example, will take longer than Trump’s term to set up. Really, the energy “3” is a price-lowering mechanism rather than a hard production target.
The growth target is realistic in historical terms (US growth has been running at about 2.7% for the last year) but it’s complicated by Bessent’s debt target. He promises growth through smaller government and deregulation – but that’s not how recent US growth has come about. Deregulation has worked in the past – notably in the Reagan years – but that was partly because Reagan could expand the deficit.
Deficit reduction is Bessent’s last “3”; he wants to get it below 3% of GDP by 2028. That didn’t happen under Reagan, and later administrations were only able to do it thanks to lower interest costs and a debt-to-GDP ratio of 40%. That ratio is now over 120%, thanks to the global financial crisis, pandemic, and significant fiscal expansion under both Trump and Biden. Trump’s cabinet wants to cut government expenditure, but seems to assume this will have no growth impact or come back through tax cuts – which would mean no deficit improvement.
Realistically, then, the 3-3-3 can’t be achieved all at once. Markets like Bessent, but we should again treat the goals seriously, just not literally.
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Andrew Lloyd
2nd December 2024