A picture of U.S. President Donald Trump is taped up on the floor of the New York Stock Exchange, on March 7.Spencer Platt/Getty Images
Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
U.S. equities have lost more than US$4-trillion in value after the administration of Donald Trump declined to rule out recession as a result of its tariff policies. What the U.S. President promised was going to be a golden age of economic growth has not, to date, transpired, and equity traders are finally punishing him for it. But given how vocal Mr. Trump was about his intentions, the question remains, how did markets not see this coming earlier?
Mr. Trump has said time and time again that tariffs are key to his policy objectives – namely bringing back manufacturing jobs, replacing traditional income and corporate tax revenues, and reducing the U.S. trade deficit.
He made good on promises to put tariffs on China in his first term, setting a credible precedent. Last October, he said that “tariff” is the most “beautiful word in the dictionary.” He promised 25-per-cent tariffs on Canada and Mexico as early as November of last year.
When he was inaugurated in January, he reiterated this intention. Four days later, Trump insiders confirmed that, while the precise nature of the tariffs was still being decided, the President was entirely serious about implementing tariffs. The situation has only become clearer since.
It is not an issue of grasping the effect of tariffs. Wall Street understands that import taxes raise production costs through the price of intermediates, which hurts profits and thus both equity values and GDP. It understands that countries tend to retaliate, crippling foreign-market access for U.S. companies.
Yet upon Mr. Trump’s election, and thus a sharp rise in the probability of these tariffs occurring, the S&P jumped upward 2.53 per cent. Furthermore, the market did not peak until Feb. 19, well after the first serious tariff announcement on Canada and Mexico. It’s as if a blackjack dealer told us the next card was high and we all hit anyway. What gives?
Market participants were apparently more focused on Mr. Trump’s corporate tax cuts, as more post-tax cash would eventually mean more dividends. But the actual passing of tax cuts did not spark a bull run – in fact the market barely moved – meaning that the tax cut was mostly anticipated by market prices upon Mr. Trump’s election.
The tariffs by contrast did not affect equity markets until days ago. One need not have a dogmatic faith in the efficient-market hypothesis to be a bit confused. Why should market-positive policies be priced in upon the slightest whiff of Mr. Trump’s intentions, while negative ones are dismissed right up until they are reality?
If Eugene Fama were asked, the Nobel laureate who developed the efficient-market hypothesis would say that it is only our updated information about the likelihood of tariffs that has led to this market rout. All prices are irrational in hindsight after all.
Clearly markets didn’t expect Mr. Trump to actually implement the tariffs, while they did expect the tax cuts. Investors were swayed by arguments that tariffs were simply a tool for bargaining (see Bank of America’s statement on Feb. 10), and that the negative growth effects of actually implementing them made them unlikely.
Alec Phillips, an economist at Goldman Sachs, said as much in early February, and JP Morgan implied that its thinking had been similar albeit earlier. By late February, before prices really started to fall, Goldman updated its outlook, finally suggesting that tariffs were not being sufficiently priced.
But there are some issues here. First and foremost, it is simply naive to dismiss tariff risk as an idle threat when both the intent and justification have been spelled out at length. Traders spend all their time trying to anticipate market movements from marginal signals and whispers of policy changes, yet here was the President telling them exactly what he planned on doing for months.
There should have been at least greater hedging and thus a more muted response upon his election. If in fact this was all posturing as part of a clever negotiating strategy, what did markets think Mr. Trump was negotiating for? Surely fentanyl was nothing more than an excuse.
Of course, there was uncertainty about the tariffs – but too many investors seemed to feel certain that there wouldn’t be any tariffs at all. Confusion and disagreement ought to have depressed equity values as traders responded to each other’s varied and volatile beliefs. Uncertainty implies risk, which should lower prices as investors demand higher returns on their money to compensate them.
While one can argue about how likely the tariffs themselves were ex-ante, the lack of clarity itself should have shown up as market volatility, and thus downward price-pressure, long before now.
Let this be a lesson for the market. Mr. Trump does not keep all his promises, but this is because he does not understand mechanisms; it is not for lack of intent. Investors should be wary of underestimating his seriousness in the future.
