Will Trump tariffs put US economic growth in jeopardy?

Who would have thought that the mayhem in the markets and the economy would be back so soon? On the back of widely discredited economic policies that have now started to impact inflation rates across the world?

Even as commentators debate the constitutionality of the Trump tariffs, the implicit assumptions driving the markets have been two-fold:

The problem with this argument is that tariffs were imposed to increase revenues that would help pay down the debt, not offset by other tax cuts.

Tariffs raise prices, and as the data indicates, the US is on track to collect its highest since 1973 in terms of percentage of tax revenues. This pushes aggregate prices higher, whilst allowing little room for interest rate cuts.

The argument that it is a one-off effect does not take into consideration the second order effects to the economy. Therefore, there appears to be another period where valuations ‘do matter’. The fact that the US dollar has been on its lowest trajectory since 1973 coinciding with new highs in gold indicates stagflation fears.

In the UAE, similar fears abound given the peg, but valuations in capital markets have started off from a different place.

Even so, the earnings results have shown a pressure on net margins coming from higher input costs, setting the stage for greater stock selection in the second-half, after an 18-month period where the DFM has outperformed its peers in the GCC and the emerging markets indices.

With a continued emphasis on inflation, companies like Salik and Parkin will continue to do well, setting the stage for further state privatisations that are ‘inflation-proof’, such as Dubai Airports and Mada.

In the private sector, there will be continued emphasis on cheap money bets spurring cyclicals, but there is a realisation that valuations are front and centre. (Regardless of the performance of the US equity markets thus far).

For those that think otherwise, they would do well to remember that AOL’s valuation peaked at $222 billion in 1999. In 2015, it was sold to a private equity company for less than $5 billion. The underlying thesis: a reduction in the emphasis of short-term interest rates will imply higher pain for interest rate sensitive sectors, and that after a long period of time, a generation of traders have woken up to the fact that there is such a thing a positive real interest rates that do all sorts of things to equity valuations.

Trump tariffs may yet be overturned by the US Supreme Court, but the longer they stay in place, the more they will impact consumer behavior and therefore underlying earnings. US equity markets (and the economy) have been the envy of the world for the last 40 years.

However, now with companies in the software sector actually building infrastructure, in the way that the robber barons did so in the times of railroads and oil showed, a period of excessive volatility and valuation compression may well be in the offing as these bets take longer to pay off. Especially given higher cost of money rates.

Investors will continue to diversify into foreign equities in search of value (as they have done so by starting to shift to the ready market in real estate). But this process will play itself out over time. The Bayesian probability theorems imply a period of adjustment that is likely in the offing, as speculation loses its sheen.