Stocks rise after Fed meeting but trade war set to escalate

The post-Fed meeting rise in shares may say more about market positioning than the interest rate outlook, as trade war prospects threaten economic growth.

Donald Trump’s more arbitrary trade policy decisions make reading inflation difficult for the US Fed — but not as difficult as during the pandemic. Picture: AFP

Stocks this week saw their biggest one-day gains for a US Federal Reserve meeting since July last year.

But, the post-Federal Open Market Committee meeting rise in US and Australian benchmarks — to their best levels in over a week — may say more about market positioning than the outcome of the meeting or any easing of recent concern about the impact of a global trade war on inflation and economic growth.

FOMC members’ interest rate projections were unchanged, as expected, and chair Jerome Powell reassuringly said the inflationary impact of tariffs would be “transitory”.

Of course, the last time the Fed said inflation was “transitory” was during the pandemic.

It was completely wrong and belatedly jacked up interest rates to the highest level since 2001.

The situation is different now, in that it’s caused by arbitrary policy choices by the US Government.

The Fed is right not to overreact. But, it doesn’t have a crystal ball for what the US President will do and how his decisions will play out in the global economy.

At the same time, FOMC members’ economic projections showed a worrying shift toward lower economic growth and higher inflation, and they were notably more uncertain.

With that backdrop, while the S&P 500 and ASX 200 fell about 10 per cent in recent weeks, the key question for investors is whether valuations are cheap enough for the market to handle the “America First” trade policy review and associated tariff increases, due to be announced on April 2.

Price-to-earnings valuations may seem enticing compared to recent years, but benchmarks in the US and Australia have been overvalued since well before the pandemic as low inflation gave central banks plenty of room to support asset prices by cutting interest rates.

Even after correcting to about 17 times forecast earnings per share for the next 12 months, the ASX 200 PE multiple is still about 16 per cent above its long-term average of 14.7 times.

That’s before any downgrades to the earnings outlook associated with a global trade war.

As of Friday the ASX 200 was about 7 per cent below its record daily close of 8555.80 points.

But, the consensus earnings per share forecast for the next 12 months had only fallen about 0.8 per cent.

The next round of US tariffs are likely to spark retaliatory tariffs, taking the trade war to a new level.

Wall Street saw a bump this week. Picture: AFP

US stocks fell 10 per cent at the start of 2018 on much smaller and narrower tariff increases.

But, unlike 2018, Donald Trump isn’t changing course after a correction in stocks.

Morningstar market strategist Lochlan Halloway warns against reflexively “buying the dip” in market-cap weighted stock benchmarks after recent corrections in the US and Australia.

“On the surface, this contrarian approach seems to have merit,” he said.

“After all, in perhaps his most famous aphorism, Buffett says (it is best) ‘to be fearful when others are greedy and to be greedy only when others are fearful’.

“However, I don’t think he was encouraging investors to jump in on every pullback.

“If you believe valuations matter — and we do — it’s not that simple.”

Mr Holloway says the key is to find where stock prices sit relative to fair value. And, despite the recent pullback, Australia’s biggest and best-known companies are “generally overvalued”.

“If you buy a cap-weighted index fund after the dip, you’ll wind up with a fairly concentrated portfolio of large, generally expensive companies,” he said.

Investors could also consider dedicated small cap funds, but should “tread carefully” because the Small Ordinaries index is “replete with unprofitable companies, many of which are exploratory miners with a long history of capital destruction.

In terms of what professional investors are expecting Trump 2.0 to ultimately deliver on trade, immigration and fiscal policy, Goldman Sachs surveyed its client base this week.

On tariffs, investors tend to see a high 65 per cent probability of a “reciprocal” US tariff, a 59 per cent chance of a US tariff on automobiles, a 57 per cent chance of tariffs on imports from the EU, a 54 per cent chance of US tariffs on critical imports and a 47 per cent chance of larger US tariffs on Canada and Mexico. Based on those numbers, such tariffs aren’t fully expected by the market.

The average investor surveyed by Goldman Sachs now expects a larger 8.6 percentage point lift in the average “effective” US tariff rate from the start of 2025 to the end. Goldman’s own estimate has risen from a 3 percentage point rise to a 10 percentage point increase in the effective US tariff.

On immigration, the average investor expects the annual pace of immigration to fall to 700,000 per year, slightly above Goldman’s own estimate, which it recently lowered from 750,000 to 500,000.

The majority expect the immigration crackdown to cause at least 10 per cent of immigrant workers without work permits already in the US to stop working or leave the country.

Given the relatively-high proportion of undocumented immigrants working construction, agriculture and hospital jobs, such cutbacks could have a significant impact on the supply of labour in those industries, potentially feeding through to higher wages and price increases.

On fiscal policy, investors expect roughly $US100bn per year in additional tax cuts — beyond extending the 2017 tax cuts — and roughly $150bn per year in government spending cuts. On average, they see minimal impact on the budget deficit.

Policy news since January has seen investors lower their 2025 GDP forecasts by 0.6 percentage points on average, versus 0.7 percentage points for Goldman and 4 percentage points for the FOMC.

Investors also raised their 2025 core PCE inflation forecasts by 0.2 percentage points, versus 0.6 percentage points for Goldman and 0.3 percentage points for the FOMC.

A crucial update on core PCE inflation for February is due next Friday.

As in the November survey, investors see tariffs as the largest policy risk.