The threat of a global trade conflict looks to have risen after Gary Cohn, President Trump's anti-protectionist senior economic advisor, resigned. Cohn had been trying to convince the president to back away from broad import tariffs on steel and aluminum. Cohn's departure helped push S&P 500 futures down around 1%.
A full-blown trade conflict could derail the global stock rally. And given the risks, we believe now could be a time for investors to consider downside protection.
But while we will go on reassessing the situation as the trade debate develops, we believe the equity rally can survive political disruptions.
- Cohn's departure is still just one step on the path to a potential harmful trade battle. Opposition to US tariffs among Republicans in Congress may help assuage protectionism, as may politically-targeted EU counter-tariffs.
- In recent years equity markets have recovered quickly from political setbacks, even when risk scenarios did materialize, such as over Brexit. This week ‘s strong showing for populist parties in the Italian election failed to unsettle investors; the spread between Italian and German 10-year yields has fallen from 143 basis points on 23 February to 130bps.
- Other political risks that have vexed markets have faded. Recent reports suggest that North Korea is willing to hold talks with the US on denuclearization in return for acceptance of Kim Jong Un's regime.
So, although the case for downside protection on equities has increased, in our base case we expect global stocks to continue to grind higher, driven by strong economic data, and we remain risk on.