If you think President Donald Trump‘s ongoing trade disputes have been disruptive, you haven’t seen anything yet.
At least that’s the message being delivered by strategists across Wall Street, who have watched in horror over the past week as the possibility of an all-out trade war has been ratcheted higher.
While an all-consuming worldwide conflict isn’t the base case for these experts, it’s become a plausible enough scenario that they’re starting to quantify the potential negative impact. And their findings aren’t pretty, particularly as it pertains to a possible economic recession.
Joseph Song, a senior US economist at Bank of America Merrill Lynch, has gone as far as to calculate the degree to which a full-fledged trade war would be a drag on US gross domestic product.
As shown in the chart below, the annualized growth rate of real GDP would decline by 0.3 to 0.4 percentage points relative to the baseline in the first year, then shave an additional 0.5 to 0.6 percentage points off in the second year.
Song argues that this negative effect on GDP, coupled with a jolt to the currently sky-high level of investor confidence, could lead to a dreaded economic meltdown.
“Trade tensions are likely to get worse before they get better,” Song wrote in a client note. “A trade war coupled with a confidence shock could push the US to the brink of recession.”
‘Things could spiral out of control’
Song’s BAML colleague, James Barty, who serves as the firm’s head of global cross-asset and European equity strategy, recently shared similar thoughts. He says while the tariffs that have been instated so far will have a minimal effect, the larger ones proposed this past week could take a bite out of the global growth forecast.
Citing data compiled by the International Monetary Fund (IMF), Barty says if the US, China, and Europe each raise import prices by 10%, then GDP would drop 2-3% in all three regions — and that doesn’t even take into account peripheral effects like supply chain disruption.
Also troubling Barty is the public rhetoric being espoused by top Trump adviser Peter Navarro and Secretary of Commerce Wilbur Ross. In his mind, those two shouldn’t be treating a possible trade war as something that can be “won,” given the major side effects such an outcome could have.
“In a worst case scenario, our economists talk of the global economy being tipped back into recession,” Barty wrote in a note to clients. “Clearly no one wants that, but when some — Navarro and Ross for example — talk about winning trade wars, then the risk is that things could spiral out of control.”
Side effects are already hitting the market
As Wall Street experts increasingly conclude that the brewing trade war could be catastrophic for the economy, investors worldwide are already reacting with their portfolios.
They pulled a record amount of money out of both global equity funds and their emerging-market counterparts over the past week, according to data compiled by EPFR Global, which pegs these risk-off outflows to — you guessed it — rising trade tensions.
Ironically enough, US and Chinese stocks saw inflows over the seven-day period, likely due to the strength of their underlying economies. So what we have is a situation where global markets outside of the two nations primarily locked in a tariff battle are suffering collateral damage.
But that’s not to say the situation in the US is completely settled. As with many potentially precarious situations in the US market, the lightning rod is tech stocks.
Michael Harnett, the chief investment strategist at BAML, notes that US tech in particular has been bucking the risk-off trend playing out globally. The sector is on pace to absorb $37 billion on an annualized basis, according to the firm’s data.
This may seem like a positive sign for the health of the market, but it can also be construed as a ticking time bomb of sorts. Investors who are cautious of a market meltdown continuously cite the unstable and speculative nature of such activity, which sees investors piling into crowded positions as they chase past performance.
In the end, we’re left with a double whammy-type situation where a potential all-out trade war has economists fearing the worst, while yield-hungry investors continue to stretch market conditions towards their breaking point. It doesn’t take an investing pro, nor a seasoned economist, to realize that this is heading for a bad conclusion.
For the time being, traders would be best served to hedge existing positions as best they can. Because if a recession does finally hit, it’s going to be jarring, no matter how prepared you are.
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