Trade war could spark US-EU stock-market crashes

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Playing with fire. Source: Mauritius Images.

Last week brought a foretaste of the stock market turmoil that could be looming if US President Donald Trump keeps escalating his trade disputes. Shares in aluminum giant Alcoa tumbled by 16 percent on Wall Street on Thursday and Friday after the increased price of metal imports forced it to issue a profit warning.

The Pittsburgh-based industrial group was one of the first stock market heavyweights to feel the impact of Mr. Trump’s aggressive tariff policies. But many analysts are warning that many more companies could follow suit.

“A trade war would be a worst-case scenario, especially for stock markets on both sides of the Atlantic,” said the chief economist of German bank IKB, Klaus Bauknecht.

Right now, that is where Mr. Trump is heading. He told CNBC last Friday he was prepared to impose tariffs on up to half a trillion dollars-worth of Chinese goods. He’s repeatedly threatened to impose duties on car imports from Europe, on top of tariffs on steel and aluminum. The EU, which has already taken steps to curb steel imports, said it would retaliate further if necessary.

All of this would lead to average tariffs rising for the first time in decades (see graphic). Michael Cembalest, the chief strategist at JP Morgan, said that if Mr. Trump carries out his threats, the US would be imposing the biggest tariff hikes since the 1930s.

Think of the consequences

While the big drop hasn’t come yet, analysts warn the prospect is still lurking in the background. Donald Trump has said he’s confident he can “win” a trade war, but the fact is an escalation would hit the US economy and financial markets particularly hard.

Analysts at UBS said US and European stock markets stand to lose at least 20 percent in a trade war, bringing the stock boom that has lasted for over 9 years to an abrupt halt. For Germany’s DAX index of 30 leading stocks, that would mean a drop to as low as 9,500 points, bringing it to the level last seen in early 2014.

Bringing the economies into balance, as Mr. Trump would like, will be painful for both sides. That’s because US consumers are currently buying foreign goods by the bucket loads: America’s gigantic trade deficit reached an all-time high of $566 billion in 2017.

In Europe, the consequences of cutting into that deficit are clear. Falling demand for exports could spark a rise in corporate insolvencies and bad debt. “In the euro zone and particularly in Germany, a reversal of the positive trade balance would lead to massive overcapacity, and hence to deflation,” said Mr. Bauknecht at IKB.

That would force the European Central Bank to push down interest rates, keeping monetary policy in the crisis mode it’s been in since the euro debt crisis. Such a decline in interest rates, while positive for stocks in general, would fail to halt declines in the share prices of exporters. Energy stocks would also be hardest hit in a trade war, because global demand for oil would fall.

First came the washing machines

In the United States, everything would be in reverse, but that doesn’t make it any better for stock markets. Cutting the deficit might revive certain industries, but the high demand for foreign goods (like German cars) means anything that raises import prices will raise the cost of these goods for consumers. One small example: The price of washing machines has jumped by 20 percent since March because of new US tariffs.

If what’s happening to washing machines becomes a larger trend, it could boost overall inflation, which in turn will force the Federal Reserve (whose job it is to keep inflation low) to respond by hiking interest rates sharply, said Mr. Bauknecht. Among other things, the rise in US interest rates would prompt investors to shift out of stocks and into US bonds, causing the dollar to appreciate and hitting share prices, analysts said.

Of course, even a trade war and damaged economy might not actually harm the stock market if investors play their cards right. Stephan Heibel, head of German analysts Animusx, says investors are relieved that no crash has come to date, but are also hedging their bets by shorting stocks. Defensive stocks such as pharmaceuticals and food retailers would also likely outperform the market, said the UBS analysts. So would safe-haven bonds such as German government paper and US Treasuries.

“Whether or not the weak economic outlook aalso shows up in the stock markets remains unclear,” said Mr. Heibel. In other words, if the downturn does come, many investors will be ready for it.

Georgios Kogologiannis is a markets expert for Handelsblatt and is based in Frankfurt. Astrid Dörner is Handelsblatt’s financial correspondent based in New York. Jürgen Röder of Handelsblatt contributed to this story. David Crossland and Christopher Cermak of Handelsblatt Global adapted this story into English. To contact the authors: Kokologiannis@handelsblatt.com and adoerner@handelsblatt.com

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