Ride out the volatility

If you have exposure, sit it out because things might get better

Back in 1987, journalist Tony Schwartz co-authored ‘The Art of the Deal’ with Donald Trump. That book was a bestseller, and hit number one on the New York Times list for many weeks. It saw a revival in interest when Trump’s campaign started. 

According to Schwartz, who says he regrets the collaboration, Trump wrote nothing but allowed Schwartz to put together many extended conversations. Trump has made conflicting statements about the level of his involvement with actually writing the book. 

The important thing from our perspective is that the book outlines Trump’s personal negotiation style. He prefers to start from an extreme position when negotiating, and he will hold that position obdurately, making small concessions only when he must. This seems to be exactly the playbook he’s using in trying to re-make America’s trade relationships. 

As of now, the ‘Trade War’ is still in a phase of escalation and it’s America Versus the Rest of the World. Trump is threatening to broaden the coverage of punitive tariffs to over $200 billion worth of Chinese exports, after both sides have put punitive tariffs on about $34 billion of each other’s exports. The US will presumably threaten similar broader punitive tariffs on exports from the EU, India, Canada, etc. If Trump holds to his normal negotiating style, he will back down only as and when, he wins some concessions. The US markets are already assuming that he will back down because US stocks have rebounded. 

One problem is, other nations don’t carry out negotiations in the same personality-driven fashion and trade negotiations are usually all about teams of bureaucrats working out endless details. The other problem is, it is unclear what Trump really wants. 

So, the chances are, the ‘Trade War’ will escalate, at least for a while. This is bad for the global economy.  It has hit commodity markets hard. Metal prices have dipped sharply due to fears that global demand may ease off. Crude prices have also declined a little even though another of Trump’s demand is that Iran be placed under sanctions again.  

The next several months, or years for that matter, are likely to see a lot of news flow from this back-and-forth of negotiations. There will be threats of higher tariffs, followed by negotiations, then there will be hopes of resolution, then threats again. Financial markets will experience wild swings as this ‘risk-off’, ‘risk-on’ process continues. 

There are several possible outcomes. The worst case scenarios involve the ‘Trade War’ sparking off a recession.  More likely, even if the ‘Trade War’ escalates, and it does noticeably impact global trade, it will cause slowdown rather than recession. The best outcomes will be a de-escalation with status quo being maintained in terms of trade and global economic activity continuing to gather momentum. 

At some stage, central bank policy will have to take note. Right now, the big three — the Bank of Japan (BoJ), the European Central Bank (ECB) and the US Federal Reserve — are tightening money supply.  Or rather, the BoJ is holding its Quantitative Easing (QE) programme at current levels, while the ECB has set a schedule for phasing out its QE and tightening, while the Fed has already started tightening. If the big three think growth is falling off a cliff, they are capable of reversing policy and easing monetary supply again. If this does happen, financial markets will go up, even if growth heads down. 

This ‘Trade War’ will mean an unpredictable, extended phase of volatility in commodity markets because traders don’t know which way demand will go. That volatility will continue until there’s some definitive conclusion to the Trade War.  Guaranteed volatility in forex rates will lead to greater uncertainty.  

The metals industry could see wild swings in profitability through the next six months to a year because of this situation. These are highly cyclical industries anyhow. But six months ago, steel, copper, nickel and aluminium manufacturers were looking at better profitability. Now that’s uncertain. It’s a similar situation for rubber. 

Investors must be prepared to ride out this period of volatility. It might be followed by a downtrend or by an uptrend. If you have exposure, you should sit it out because things might get better. If you don’t have exposure to highly cyclical commodities, you should probably avoid taking any until and unless prices fall a good deal further.