The year-end stocks rally on the heels of the election of Donald Trump as US 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 signalling Trump's campaign promises to revisit trade deals and even impose a tax on all imports are very much alive. Among the policies favoured 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 US election. Harsher trade policies may not cause a full economic slowdown, "but I'd expect a localised 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 favourite industries."
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