Rising trade tensions, new tariffs and protectionist threats are threatening the upside potential of both stock prices and bond yields. Were it not for these risks, we think equity markets would likely have moved higher this year and government bonds would be under more pressure.
Even more than the actual negative economic impact, the uncertainty over trade policy is worrying investors. It is increasingly uncertain if President Trump actually wants a full-fledged trade war that will allow him to claim some sort of political victory. If so, the global economy could be dragged into a slowdown or recession. While logic would suggest that no one actually desires a trade war, cooler heads have not been prevailing and risks are rising. Our best guess is that tensions will eventually ease, but our concerns are growing.
So far, financial markets have remained fairly solid in the face of these pressures. Corporate earnings are helping stocks prices and bond yields have remained relatively low even as economic growth improves, inflation rises and the Fed remains committed to additional rate hikes.
How does this affect our investment outlook? We maintain a mostly optimistic view toward equities and other risk assets, but admit to having less conviction than normal in this belief. Over the next 6 to 12 months, we are forecasting modest equity gains and a further erosion in government bond market returns. We see few signs that the current economic expansion is ending, despite trade risks, a possible slowdown in capital expenditure spending and some weakening of economic growth in some areas of the world. As such, we think it would be premature to adopt a more defensive investment stance.