Gaming Trump’s proximity to the ledge

A virtual crowd has gathered beneath the ledge where President Trump now sits, making book on whether he will back away or come crashing down on the pavement below.

Trump’s decision to impose tariffs on Mexican imports on the dubious strength of a 1977 emergency law, and the evident confusion in his administration about the purpose of the measure, has taken the trade war in a new and dangerous direction.

Every broker and investor in the world is staking their strategy on one question: Will Donald Trump ease back from the ledge?

JPMorgan’s Adam Crisafulli weighed in on the matter in an email to clients on Sunday:

“Domestic growth clouds were forming even before the most recent escalation of trade tensions and softening economic momentum could very well curb Trump’s worst policy instincts but it will probably require material weakening from here to catch his attention (Trump, along w/the general public, are most responsive to monthly jobs reports and the quarterly GDP releases but both tend to be somewhat lagging and thus may not reflect a substantive slowdown before it’s too late).”

I’ve been warning almost daily (see my May 30 report) that the US economy has slumped into little or no growth during 2019. Now a crowd of commentators is warning that Trump’s trade wars will push the US into recession – just in time for the 2020 presidential elections.

Morgan Stanley’s chief economist Chetan Ahya warned in a June 2 note to clients, “If trade tensions continue to escalate, with the US imposing 25% tariffs on the remaining US$300 billion of imports from China and China responding with countermeasures, we believe that the global cycle will be at risk. We could end up in a recession in three quarters.”

The Morgan Stanley strategy team added: “With US data still above-average but deteriorating, our cycle indicator has shifted out of ‘expansion’ to ‘downturn’ for the first time since 2007. This phase-change has historically meant a worse backdrop for returns and higher chances of recession or a bear market.”

Goldman Sachs’ survey of equity analysts, which evaluates growth and contraction at the company level, now points to a disastrous slump in industrial orders. 60% of the companies covered by the survey reported falling orders.

There’s only one person in a position of responsibility who still believes that the US economy is doing well, and that’s the president, who seems to be making it up as he goes along.  In a weekend tweet, he wrote that “companies are moving to the US” in response to his tariffs, and that “TARIFF is a beautiful word indeed.”

His top aides, meanwhile, insisted that last week’s threat to impose tariffs on Mexico stemmed from security rather than economic considerations.

For example, Chief of Staff Mick Mulvaney told Fox News on Sunday that the tariffs were “an immigration matter, not a trade matter.” Trade adviser Peter Navarro said that the tariffs had “zero” to do with the American auto industry. But the president tweeted Sunday morning that “our many companies and jobs that have been foolishly allowed to move South of the Border, will be brought back into the United States through taxation (Tariffs). America has had enough!”

Trump reportedly ignored objections to the Mexico tariffs from US Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, and adviser Jared Kushner, relying rather on the counsel of White House speechwriter Stephen Miller, who spoke to the president at length on the flight back from Tokyo last week.

Trump seems to believe that the US economy is strong and the Chinese economy is ready to crack, but it is unclear who is briefing him. The China experts at the Central Intelligence Agency and the National Security Council do not share this view, but there is no indication that staff evaluations are getting to the Oval Office.

No meeting of the Principals Committee or even the Deputies Committee has been convened at National Security Council to consider what retaliatory measures China might take, for example, an embargo on shipments of rare earth minerals to the United States.

The Mexican tariffs have had a profound impact on Chinese thinking. China’s central complaint against America’s negotiating strategy involved America’s insistence on the unilateral right to impose new tariffs in the case that bilateral negotiations failed to solve disputes.

That, China objected, would give the US arbitrary power over China. The imposition of tariffs on Mexico in the midst of a trade treaty now before the Congress persuades the Chinese that Trump will not respect any agreement that they make with him.

Until the collapse of US-China trade negotiations a month ago, many Chinese reformers believed that America’s demands for Chinese economic reforms would strengthen their hand against heavily-subsidized state-owned enterprises.

Policymakers in the Communist Party’s Central Financial and Economic Affairs Commission headed by Liu He hoped that Trump’s tough talk would speed Chinese reforms. That view of Trump has vanished, and China is hunkering down for what may be a prolonged trade war.

It’s noteworthy that Chinese A-shares outperformed most American equity indices during May. The Shanghai Composite lost 5.6% during May, versus a drop of 8% for the US Nasdaq and Russell 2000 indices, and- 6.4% for the S&P 500. Large-cap Chinese stocks have limited export exposure. I continue to recommend ultra-safe US stocks with stable cash flows and Chinese A-shares in preference to the S&P 500.