Markets showing signs of fragility as the grim reality of a global trade war sinks in

It’s clear US President Donald Trump isn’t backing down from his aggressive trade policies despite sharp drops by stockmarkets, meaning shares could be in for even bigger falls.

US President Donald Trump flanked by Irish Prime Minister Micheal Martin and his wife Mary a St Patrick’s Day reception this week. Picture: AFP

The grim reality of a global trade war is sinking in and it’s not good news for stocks.

In the past week it has become clear that US President Donald Trump is determined to pursue his aggressive trade policies even after sharp falls in stocks – so they could be in for even bigger falls.

Before Mr Trump last week started to downplay the US economic impact of tariffs and Treasury Secretary Bessent spoke of a “detox” period for the US as it decreased its reliance on public spending, the prevailing view was a 10 per cent fall in the S&P 500 would be all they could stomach.

But the strike price on that theoretical “Trump put” option may be lower than previously thought. That idea was reinforced at the start of the week when Mr Trump declined to rule out a recession in the US economy, saying that it faced “a period of transition because what we’re doing is really big”.

Stockmarkets here and in the US are now on the cusp of “technical correction” territory, defined as a fall of at least 10 per cent from their bull-market highs.

However, economists and strategists have only just started to lower their lofty expectations.

On Monday, HSBC strategists cut US stocks to neutral, seeing “better opportunities elsewhere for now”.

On Wednesday, Citi strategists also cut their view to neutral, saying that “US exceptionalism is at least pausing”, and Goldman Sachs lowered its S&P 500 price target from 6500 to 6200.

On Thursday, Morgan Stanley cut Australian stocks to underweight.

Of course the stockmarket can move much faster than the economy but, at least in terms of volatility, the VIX index hasn’t had the kind of blow-off that would suggest the bottom is in.

The sequencing and magnitude of US policy change under Trump 2.0 is much less market friendly than Trump 1.0 and he seems less sensitive to the stockmarket than he was at that time.

On top of that, US fiscal policy looks maxed out and inflation is much higher than it was in 2018.

The S&P 500 dipped 10 per cent at the start of 2018 when the US started lifting tariffs.

But Goldman Sachs now foresees the average US tariff rate rising by 10 percentage points this year – twice as much as its previous forecast.

Of course the US Federal Reserve could always cut interest rates in response to a sharp fall in stocks.

But with core PCE inflation still well above target and the Fed currently gauging the economic impact of Mr Trump’s policies, it’s fair to assume that any “Fed put” is even lower than the “Trump put”.

Interesting in that regard was a Wall Street Journal report covering the Yale CEO Caucus where CEOs on the whole were concerned about Mr Trump’s policies but reluctant to openly question them.

“When asked how much the stockmarket would need to decline for them to speak out collectively, 44 per cent said it would have to fall 20 per cent from the record high.

Another 22 per cent said stocks would have to fall 30 per cent before they would take a stand.

“The inference being the Trump ‘put’ could be a lot lower than where some people think,” NAB head of market economics Tapas Strickland said.

Of course Australian stock market valuations will come down if global valuations fall.

With a 12-month forward price-to-earnings ratio of 17 time versus a long-term average of 14.7 times, the ASX 200 can hardly be considered cheap.

The big banks account for a big part of its overvaluation. And while the ASX 200 Banks index has fallen 14 per cent in the past four weeks, it would need to fall another 22 per cent to come back to its long-run average valuation of just about 12.4 times.

On Thursday, Morgan Stanley cut its his rating on the Australian stockmarket to underweight, based on its valuation and trade exposure to a burgeoning trade war.

Australia doesn’t have much direct exposure to US tariffs like the aluminium and steel levies that started this week. But it has plenty of indirect exposure via commodity exports to China and Europe where tariffs are being ramped up and could go higher as they retaliate against the US.

“We recommend investors generally reduce exposure to high relative valuation markets and tilt toward markets with domestic and/or idiosyncratic drivers, while looking for further areas of leadership transition and portfolio reallocation,” Morgan Stanley head of Asia-Pacific quantitative research and Asia/EM equity strategy Daniel Blake said.

Reversals of intraday strength in US and Australian stocks that followed the release of lower-than-expected inflation data on Wednesday were telling. The data largely predated tariff increases and the bigger-than-expected fall in the monthly CPI largely reflected a fall in the price of airfares.

It came as US steel and aluminium tariffs of 25 per cent took effect. The EU has retaliated by imposing measures on goods worth some €26bn and Mr Trump threatened to respond to that retaliation. Canada also responded, imposing measures on US goods worth some $C30bn.

“Certainly, it is clear that there has been little progress on inflation – and arguably there has been some deterioration – since the Fed commenced the easing process in September 2024,” GSFM investment specialist and former BlackRock head of fixed income Stephen Miller said.

“So the ‘stagflation-lite’ scenario remains plausible.”

He said that in the broader scheme of things there was still a lot to worry about and “episodic volatility may be a durable theme for equity markets in the months ahead”.

“Markets have already dramatically reassessed the likely consequences of the Trump administration’s policies on financial markets,” Mr Miller said.

“Markets had been pricing a goldilocks scenario of declining inflation, declining interest rates and strongly performed equity markets.

“That euphoria – reflected in richly priced risk markets – has reversed sharply.”

When Trump became US president again the prospects of a US recession in 2025 were small.

But fewer than two months into his term that risk is over 50 per cent according to Mr Miller.

And US authorities are “less equipped to deal with a recession than they have been for some time”.

Originally published as Markets showing signs of fragility as the grim reality of a global trade war sinks in