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Trump's market honeymoon threatened by trade stance

The postelection rally in U.S. stocks seems to be rooted in the market's faith in Donald Trump's economic agenda, while the risks of the next president's more radical policy ideas are being dismissed.

That balance is bound to tilt back to the potential downside of the Trump agenda, leaving recent equity gains vulnerable, according to Peter Berezin, managing editor of Montreal-based BCA Research.

"The stock market's honeymoon with Donald Trump may not last much longer," Mr. Berezin said in a report.

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Mr. Trump's hostility to globalization and free trade could prove more destructive than the market currently calculates, he said.

Since Mr. Trump emerged the victor nearly three weeks ago, the S&P 500 index has appreciated by 3 per cent. The appreciation has defied the consensus expectation for a sell-off under a Trump upset victory scenario. While substantial, that index movement understates the powerful underlying rotation between major sectors, as investors have been recalibrating their portfolios for a new era. Defensive and rate-sensitive stocks have fallen out of favour, while cyclicals have spiked.

Financials and industrials sectors have led, posting 11-per-cent and 7-per-cent gains, respectively, since election night, while the S&P 500 banks index, specifically, has advanced by 14 per cent in fewer than three weeks.

A similar trend has materialized in Canada, with financials and industrials driving index gains, while real estate stocks and utilities have been among the biggest losers.

The rush toward more economically sensitive stocks suggests the market is optimistic that Mr. Trump can stimulate growth as promised.

And certain elements of the Trump agenda, such as corporate tax cuts, deregulation and fiscal stimulus are generally supportive of stocks. Threats to global trade, however, are not, Mr. Berezin said.

"It cannot be denied that Trump's anti-globalization rhetoric represents a direct threat to corporate earnings," he wrote.

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"While some of Trump's protectionist proposals will undoubtedly be watered down, investors are underestimating the likelihood of disruptive trade measures. Unlike on most issues where he has flip-flopped repeatedly, Trump has consistently espoused a mercantilist view on trade since the 1980s."

China has been one of Mr. Trump's more reliable targets, labelling the country a currency manipulator.

Raising the tension with China is liable to land the United States in a trade war with "one of the most important countries in the world," Steve Hanke, an economics professor at Johns Hopkins and director of the Cato Institute, wrote on a blog last week.

The potential damage to the economy and corporate profits from trade disputes has BCA cautious on global equities, Mr. Berezin said. He said he's positioned for that view by shorting Nasdaq 100 futures.

"Globally exposed large-cap tech stocks will suffer the most from a turn towards trade protectionism," he said, also noting Mr. Trump has targeted the main visa program for foreign technology workers admitted to the United States.

The lift to U.S. growth that investors seem to be expecting to flow from Mr. Trump's fiscal stimulus also has its skeptics.

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Considering the relatively low U.S. jobless rate, "we just don't see the room to accelerate much beyond a 2-per-cent average pace in 2017-18 before the additional demand will push American inflation rather than output," Avery Shenfeld, chief economist with CIBC Capital Markets, said in a note. The pressure on stocks from protectionist sentiment is also likely to spread to emerging markets, the BCA report said.

The pillars of Mr. Trump's policy agenda – fiscal stimulus, tighter immigration and higher tariffs – are all inflationary. That, in turn, will make U.S. interest-rate hikes more likely, opening up a rate differential between the United States and the rest of the world.

Higher U.S. rates should draw capital into the United States, keeping the U.S. dollar well bid. And a stronger U.S. dollar tends to put downward pressure on commodity prices.

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About the Author
Investing reporter

Tim Shufelt joined the Globe and Mail in August, 2013, primarily to cover investments for Report on Business. Prior to the Globe, he worked as a staff writer at Canadian Business magazine, a business reporter at the Financial Post, and covered city news and courts for the Ottawa Citizen. More

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