In recent weeks, U.S. stock markets have moved up and down in response to issues that go well beyond the traditional direct drivers of economic growth and corporate earnings. These “known unknowns,” to borrow a phrase from former Defense Secretary Donald Rumsfeld, include the aftermath of the currency crisis in Turkey, the trade tariffs and sanctions skirmishes, the more uncertain outlook for the global economy and the exit from unconventional monetary policy.
The moves in U.S. asset prices, whether up or down, have often appeared exaggerated when assessed calmly in light of the longer-term influences of these factors. (The issue is different for other technically fragile asset classes such as emerging markets, or for directly impacted countries such as Turkey.)
As unbalanced portfolio reactions are the major risk for U.S. equity investors, here’s an assessment of the big four known unknowns. This list of concerns, by order of importance for investors in U.S. assets (from high to low), is based on a combined assessment of both the probability of bad outcomes and their potential impact.
More uncertain global economy:
For some time, advanced economies were relatively correlated in terms of growth performance. Coming out of the 2008 global financial crisis, a protracted period of frustrating “new normal” growth (unusually low and non-inclusive) was followed by promising signs of a synchronized pick-up. This has now given way to much greater divergence, with the U.S. notably outpacing other advanced economies.
Accompanied by worries about China’s growth prospects, there are interesting questions about how long this divergence can persist and how it will ultimately be reconciled.
It makes a huge difference to U.S. corporate earnings if the advanced countries’ average growth rates end up converging to higher U.S. levels or if, instead, America’s is pulled down. This is particularly true in a world of high debt and depleted policy ammunition to fight a serious economic downturn. And, in the journey to this resolution, exchange rates and interest rate differentials could be subject to considerable strains.
Trade policy:
The global trade system has been questioned by the Trump administration, which is frustrated by both the persistence of unfair practices and the lack of modernization of some key arrangements. The U.S. response has been to raise the ante by imposing tariffs and threatening to implement more on China, the European Union, Canada, Mexico and others. These moves are all part of a general trend of more aggressive use of economic tools for political and geopolitical purposes.
As long as the U.S. is willing to sustain some possible damage, it is destined to win the skirmishes. Realizing this, some trading partners (including the EU) have adopted a more conciliatory tone after the initial tit-for-tat responses.