Don’t Seize the Sell-Off

SINGAPORE

Investors who chased the S&P 500 higher immediately after US President Donald Trump was elected in November last year might now be wondering what they were thinking.

Within a fortnight of his inauguration, Trump announced import tariffs on Canada, Mexico and China. Last week, he imposed tariffs on most of the rest of the world.

The Tariffs

In his executive order last Wednesday (Apr 2), he reiterated many of the grievances about global trade he had openly expressed on the campaign trail. He asserted that the US suffers from lopsided bilateral trade relationships that have hollowed out its manufacturing base, undermined its supply chains and rendered its defence-industrial base dependent on foreign adversaries. He also grumbled in the executive order that foreign companies are now better positioned to scale production, invest in innovation and compete in the global economy.

Despite widely telegraphing his intention to address this perceived unfairness, the import tariffs he announced seemed to catch many investors on the back foot.

Market Reaction

The S&P 500 ended last week down 9.1 per cent, while the Nasdaq 100 was 9.8 per cent lower. The 10-year US Treasury yield sank to 3.99 per cent, from 4.26 per cent at the beginning of the week. Markets around the world also took a beating: the Stoxx Europe 600 was down 8.4 per cent; the Nikkei 225 sank 9 per cent; and the Hang Seng Index fell 2.5 per cent. Here in Singapore, the Straits Times Index was down 3.7 per cent.

One Possible Reason

One possible reason for the market’s negative reaction is that many investors might have assumed that Trump was only using the threat of tariffs as a bargaining chip; and they were perhaps more focused on the tax cuts and deregulation that his administration is expected to deliver.

Another Possible Reason

Another possible reason for the widespread nervousness is that the tariffs were much higher than many investors expected. Trump imposed a baseline 10 per cent tariff on all countries, which took effect on Apr 5. On Apr 9, a higher individualised "reciprocal tariff" will be imposed on countries against which the US is running trade deficits. All other countries will continue to be subject to the baseline 10 per cent tariff.

Reciprocal Tariffs

Among the larger economies that will be hit with these reciprocal tariffs are China, the European Union and Japan – they are to pay 34 per cent, 20 per cent and 24 per cent, respectively. Apart from the tariffs being higher than expected, they also seem to have been set rather arbitrarily. Some observers have pointed out that the reciprocal tariffs were calculated by taking the trade deficit that the US runs with the country in question, and dividing it by the exports that country sends to the US. Then, to be "kind", that number was halved to arrive at the reciprocal tariff rate.

Retaliatory Tariffs

Much now depends on how nations around the world react to the new tariffs. While Trump has threatened even higher tariffs on countries that retaliate, he has also left the door open for US trading partners to appeal for lower tariffs in exchange for something "phenomenal". Trade-dependent economies in South-east Asia have a great deal to lose, and are most likely to be wary of making things worse by retaliating, in my view.

US Dollar Weakness

Against this uncertain backdrop, investors around the world are probably in for a rough ride. Trump’s tariffs will almost certainly weigh on global economic activity and corporate earnings in the months ahead. Even if some economies in South-east Asia manage to cut deals that lower their reciprocal tariff rates, the Trump administration’s general attitude towards trade has probably negated a major element of their growth story for investors. It may also be just a matter of time before investors begin worrying about the durability of the US dollar as the pre-eminent global reserve currency.

Conclusion

The way I see it, investors should not be in a hurry to take advantage of the recent market sell-off; and they should keep their Fomo (or fear of missing out) in check in the event of a relief rally. It could be several months before the current shake-out runs its course.

FAQs

Q: Why did the S&P 500 drop sharply after Trump’s tariffs announcement?
A: The S&P 500 dropped sharply due to a combination of factors, including the unexpected magnitude of the tariffs, concerns about global trade tensions, and the potential impact on corporate earnings.

Q: What is the difference between the baseline 10 per cent tariff and the reciprocal tariff?
A: The baseline 10 per cent tariff is a uniform tariff applied to all countries, while the reciprocal tariff is a higher individualised tariff applied to countries with which the US has a trade deficit.

Q: Which countries will be most affected by the tariffs?
A: The tariffs will affect a broad range of countries, including China, the European Union, Japan, and many smaller economies in South-east Asia.

Q: Will the US dollar continue to weaken in the face of trade tensions?
A: Yes, the US dollar may continue to weaken if trade tensions persist and global investors become increasingly concerned about the impact on the global economy.