REUTERS - The year-end stocks
rally on the heels of the election of Donald Trump as U.S. president was built
on expectations of reduced regulations, big tax cuts and a
large fiscal
stimulus.
Now signs are emerging
from the Trump camp that harsher trade policies that could jeopardize the
honeymoon are likely in the offing, and investors would be well advised to give
those prospects more weight when gauging how much further an already pricey
market has to run.
By naming China hawk
Peter Navarro as head of a newly formed White House National Trade Council, the
incoming administration is signaling Trump's campaign promises to revisit trade
deals and even impose a tax on all imports are very much alive.
Among the policies
favored by Navarro and Trump's pick for commerce secretary, Wilbur Ross, who
has the president-elect's ear on a range of economic issues, is a so-called
border adjustment tax that is also included in House Speaker Paul Ryan's
"Better Way" tax-reform blueprint.
If implemented,
economists at Deutsche Bank estimate the tax could send inflation far above the
Federal Reserve's 2 percent target and drive a 15 percent surge in the dollar.
Analysts calculate
that, all else being equal, a 5 percent increase in the dollar translates into
about a 3 percent negative earnings revision for the S&P 500 .SPX and a
half-point drag on gross domestic product growth. The dollar index .DXY has
already gained more than 5 percent since the U.S. election.
Harsher trade
policies may not cause a full economic slowdown, "but I'd expect a
localized recession in manufacturing and smaller gains in factory employment as
well," said Brian Jacobsen, chief portfolio strategist at Wells Fargo
Funds Management in Menomonee Falls, Wisconsin.
He said the border
tax could trigger retaliation, pouring uncertainty into the market.
"Even if the
drafters of the legislation have pure intentions, other countries could use
this as a pretext for propping up or subsidizing their own favorite
industries."
TOP ECONOMY RISK
Stocks have rallied
broadly since Nov. 8, with the S&P 500 advancing by 5.7 percent and the Dow
Jones Industrial Average .DJI surging nearly 9 percent to brush up against the
20,000 mark. Some sectors, such as banks .SPXBK, have shot up nearly 25 percent
in the post-election run.
U.S. equities have
gotten substantially pricier from a valuation vantage as well. The forward
price-to-earnings ratio on the S&P 500 has risen by a full point since
Election Day, from 16.6 to 17.6, Thomson Reuters data shows. That makes stocks
about 17 percent more expensive, relative to their earnings potential, than
their long-term average multiple of around 15.
Small caps have
gotten pricier still. The forward multiple on the Russell 2000 has risen to 26
from 22 on Nov. 8, up 18 percent, while the index price has climbed 14 percent.
S&P 500 earnings
are expected to rise 12.5 percent next year, according to Thomson Reuters
Proprietary Research estimates. Anything that impedes companies from achieving
that target, such as a bump from a trade spat or further dollar appreciation in
anticipation of new trade barriers, would undermine equity valuations.
In the latest
Reuters poll of U.S. primary dealers, economists at Wall Street’s top banks
cited Trump’s evolving trade policies over other factors, such as fiscal
policy, a strong dollar and higher interest rates, as the greatest risk to the
near-term economic outlook.
The idea of a tax on
imports "should alarm people," according to Michael O’Rourke, chief
market strategist at JonesTrading in Greenwich, Connecticut.
"If we do have
a trade war that's going to be a major negative" for stocks, he said,
adding that the upward momentum in equities, alongside the lack of
participation due to the upcoming holidays, have so far prevented a repricing
but "we could cap the rally here, that could very well happen."
O'Rourke said
technology, a sector that represents the globalization trade, would be among
the hardest hit by taxing imports.
Deutsche Bank's auto
sector equities analyst estimated the border tax could slam other industries
that rely on global supply chains, with the cost of a new car, for instance,
jumping by as much as 10 percent.
REUTERS
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