Equity markets were staging a comeback from early February’s plunge, but then came news of President Trump’s intention to impose tariffs of 25 per cent on imported steel and 10 per cent on imported aluminium. The surprise announcement tumbled global bourses two weeks ago but they have since rallied on news of possible tariff exemptions. While markets have picked up, volatility remains elevated. The VIX index, a widely followed measure of market volatility, is currently trading around 15, more than 35 per cent higher than its average of just 11 during all of 2017.

Not that this year’s volatility can be blamed entirely on a looming trade war. Certainly, rising interest rates and incoming Fed chairman, Jerome Powell’s more hawkish stance on monetary policy have also had an impact. Nevertheless, the potential unwinding of decades of globalisation creates new uncertainties.

Most economists would disagree with President Trump’s recent tweet that ‘Trade Wars are good and easy to win.’ While free trade does not always benefit everyone, experts mostly agree that globalisation creates more efficient markets by lowering costs and spreading wealth more equally. If each nation is allowed to specialise in what it does best and is able to trade freely with the others, consumers and companies generally reap the benefits.

A recent study showed the price of an Apple iPhone would roughly double if its components were made and raw materials sourced only in America. Lower prices on electronic goods, automobiles, aeroplanes and myriad other items supports great volumes and better profits across the board. Tariffs only add to the coffers of bloated governments, most of which cannot even balance their own budgets. Nevertheless, some countries such as China are notorious for subsidising their domestic industries and creating artificially low prices which have had an adverse effect on their international counterparts.

Strategists in Washington and on Wall Street are sifting through potentially new rules for the old game of trade. Front and centre is the concern over China’s steel and aluminium subsidies. The US, for example, had been the world’s largest producer of primary aluminium for many years, accounting for about 30 per cent of global supply. But now America produces less than 4 per cent of the total. Meanwhile, China has risen to become the world leader, producing approximately 54.4 per cent of global volumes.

Part of the debate is over national security issues. The US has gone from having 23 operational aluminium smelters in 1993 to just five. Only one of the remaining smelters makes the high purity aluminium required to build military jet fighters.

While national security may be an issue, the discussion is mostly about jobs. Employment was certainly the reason behind China’s ‘make work’ policies which led to a global glut of raw materials; and clearly employment is central to the White House debate over metals tariffs. While Trump has been widely criticised on the tariffs, it is worth noting the President is merely reverting back to his campaign promise of attempting to bringing manufacturing jobs back to the US.

Opponents of the broader trade measures, however, argue that any benefits from protecting two relatively small American industries will be more than offset by a potentially more sweeping employment shake out in other industries impacted by rising input prices. Stocks in the automobile and capital goods sectors, likely to be hurt by higher metals prices, sold off on Trump’s announcement. Of course, the total impact would likely be much more severe if other nations decide to retaliate and place tariffs of their own on key US export sectors such as aerospace, defence and agriculture.

Markets caught a bid last week as Trump walked back the notion of across-the-board tariffs, saying Canada and Mexico would be exempted for now but could be hit later if those countries fail to renegotiate the North American Free Trade Agreement. Before signing an executive order last Thursday, Trump suggested other countries could be exempted, too, but only if they treated the United States “fairly.” While Trump is open to further negotiations with America’s closest allies, his stance remains firm on protecting certain industries.

The key to equity market performance in the months ahead remains strength in the underlying global economy. We came into 2018 with the tailwind of a synchronised global economic recovery in addition to a US tax cut which created an attractive set up for rising corporate profits. While a few signs of weakness are apparent, mostly the reflation trade remains intact.

We must now wait to see how the battlefield over global trade ultimately plays out and discern if resurgent nationalism begins to take a toll on growth. We hope America’s protectionist trade stance does not develop into a more serious backlash against globalisation. Over in Europe, the consequences of last year’s Brexit vote are still unresolved and may come with its own package of tariffs. In many parts of the world we have seen growing opposition to the free movement of goods and people which has defined the neoliberal agenda for decades.

Our base case is a continuation of the global reflation scenario, at least through the balance of this year. Yet other outcomes are possible and those are largely in the hands of government policymakers. In this less certain macroeconomic environment, retaining some defensive issues, including fixed income and bond proxies such utilities, REITs and consumer staples in your portfolio can provide a hedge against adverse surprises on trade. Smaller cap domestic ‘value’ companies with lesser international exposure have underperformed the broader averages and may also be due for a rebound.

Bryan Earle Dooley, CFA is the Senior Portfolio Manager and General Manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.