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GMO’s Inker: Now Is a Dangerous Time for a Trade War

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The stock markets were unhappy Friday when President Donald Trump moved to impose tariffs on steel and aluminum imports. Trump even tweeted “trade wars are good, and easy to win.”

Not so fast, says Ben Inker, head of asset allocation for Grantham Mayo Van Otterloo & Co.

“He is wrong, and beyond the simple fact of his wrongness, a trade war is probably more dangerous for investors at this time than at any other time in recent history given the implications it would have for inflation, monetary policy, and economic growth,” said the GMO board member in a note to investors on Friday.

“The only positive from the tariffs is that it is a windfall profit increase for U.S. producers of steel and aluminum, which is at least positive for them,” he explained.

“It is unlikely to cause any material increase in U.S. capacity to produce steel and aluminum and therefore unlikely to lead to many additional jobs even in those sectors,” Inker said.

How bad could the consequences be?

“The negatives are much more significant,” the asset specialist wrote. “I believe these tariffs on their own will push inflation higher, and higher inflation is a threat to the valuations of more or less all financial assets today.”

Other consequences of Trump’s moves are that a trade war would boost prices on a broad swath of goods and services, while lowering aggregate global demand.

“This pushes us in the direction of not just inflation but stagflation, where both valuations and corporate cash flow would be under pressure,” Inker explained.

While a significant inflation problem could be the worst thing to happen to a balanced portfolio, producing losses on the order of 40%, he adds, a global trade war would “be exactly the kind of economic event that could foreseeably lead to losses of that magnitude.”

Job Losses How are jobs lost in a trade war?

“There are hugely more U.S. workers involved in making the products that use steel and aluminum than there are U.S. workers directly in those sectors,” according to the GMO board member, “and these tariffs and the resulting higher domestic prices for steel and aluminum relative to prices in the rest of the world suddenly make the U.S. a less attractive place to manufacture anything which uses those inputs.”

While it’s true that that the manufacturing sector does not represent a large percentage of total U.S. jobs, tariffs likely would “increase U.S. inflation, decrease growth, and decrease our export competitiveness,” he adds. “And this ignores the impact of (what is extremely likely to be) retaliatory measures by U.S. trade partners.”

Big Fear The real danger of Trump’s tariffs is if they create a full-blown trade war. “It can take years for companies to build out their global supply chains. With the stroke of a pen, political leaders can make those supply chains instantly far more expensive,” Inker said.

Without an easily available replacement for foreign supplies, tariffs lead to large price hikes. That then would “force the hand of the Federal Reserve to raise rates more aggressively than is currently planned, without any corresponding positive such as would come from an unexpectedly strong economy,” he explained.

A trade war might prompt investors to shorten their time horizons, “which is a negative for long-duration risky assets such as equities,” Inker writes.

“If one wanted to imagine a scenario in which valuations fall not merely to long-term historical averages but right through onto the other side, a global trade war is a strong candidate,” he said.

Despite the risks mentioned above, GMO is not adjusting its portfolios, as it has already positioned them for other factors — such as the inflation threat.

“In our multi-asset strategies generally, we have lower than normal weights in risky assets, less than normal duration, and own significant amounts of [Treasury inflation-protected securities], which provide at least some inflation protection. While we by no means welcome these tariffs, we are comfortable with our current positioning given them,” Inker said.

He sees the unilateral tariffs as being worse for U.S. companies than for the rest of the world.

“A full-blown global trade war would be a different matter, and we would expect emerging companies as the suppliers to the developed world to be particularly vulnerable,” he added.

Nobody wins a trade war. That means investors “would lose along with everyone else” if one were to take place, Inker says.

— Check out GMO’s Inker: How to Chase Alpha Like Your Life Depends on It on ThinkAdvisor.


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