TINA McRAE says 'Watch out ahead!'
While on a client trip through Europe and North America, I have seen investors go through all five stages of financial market grief about the US: confusion, fatalism, denial, revulsion – and reallocation
What a time to be on a client trip through Europe and North America. The ‘US exceptionalism’ narrative that prevailed between the election and inauguration had already broken by mid-March. As the news unfolded in April and daily market convulsions ensued, I noticed a deeper thread in the questions and observations from clients, and also from peer chief economists at an international meeting in Basel: the mood has shifted from ‘US exceptionalism’ to ‘US revulsion’.
Prior to ‘Liberation Day’, and in the first few days after, many institutional and official sector investors simply didn’t know which way to jump. They had little conviction about the direction of the market and were therefore taking little risk. The next stage of market grief after the freeze of confusion was a kind of fatalism. Yes, the US looks a lot less attractive and the US dollar is overvalued, they would say, but nothing is deeper and more liquid than the US Treasury market; one can’t get out of it. This is the ‘TINA problem’ – There Is No Alterative – that we have discussed previously.
A couple of US-based clients were detouring through the denial phase of grief. They highlighted the US’s entrepreneurial dynamism and were holding on to the prospect that the US would continue to enjoy a growth differential over other Western economies, perhaps following some unspecified deregulation by the Trump administration. Most US-based contacts, though, were even more strongly in the Revulsion phase than their European peers. As one US-based client commented, “America is cooked”.
That’s the thing with narratives. Once you start to see the cracks in a narrative, you start to question things more broadly. Tariff policy and bullying of close allies opened up the crack. But then the high valuations in the equity market, previously shrugged off, start to look more concerning. So does the parlous fiscal position of the US government and the incapacity of the US political system to solve this and other problems. Then some of the wilder ideas of Trump administration officials – like coercively converting US Treasury bonds to non-marketable zero-coupon paper – start to be seen as genuine – and alarming – possibilities. The previously unthinkable becomes plausible.
Then came the revulsion, the simultaneous sell-off in the US dollar, bonds and equities. There is still a TINA issue – There Is No Alternative to the US Treasury market. Selling out of US markets entirely is infeasible, for all the talk about US markets becoming uninvestible. There is, however, also McRAE – Markets Can Reallocate Easily. Right now everyone wants to be at least a bit less long US markets. Thus the final stage of market grief is reallocation. And because it is flows that determine pricing, not legacy stocks, with reallocation comes repricing: TINA McRAE.
What, then, are investors and asset managers looking to reallocate into as they reallocate out of the US? Everywhere, but for now mostly Europe; it is the ‘adjacent possible’. Even before Liberation Day, we heard, equity investors were looking at Europe in a more positive light. This is especially true for the defence sector. The Trump administration’s treatment of Ukraine, Canada and its NATO allies has been as much behind investor revulsion as the chaotic tariff policies. Germany’s constitutional change and pivot to increased defence spending was something of a catalyst for the shift in thinking, too.
More broadly, people are noticing that Greater Europe – including not just the euro area or even the EU but also others in the region such as the UK, Switzerland and Norway – represents an enormous and reasonably integrated economic market, even if not an integrated and homogeneous bond market. It is also a region that has been driven by the Trump administration’s behaviour to seek ways to extricate itself from dependence on US defence and tech sector vendors. On this front, broader cooperation with Canada and Australia – a kind of ‘Eurovision plus one’ grouping – was widely discussed in my recent meetings with clients. (Canadian clients were already aware and others interested to hear about Canada’s decision to purchase Australia’s JORN over-the-horizon radar technology.)
Within this broader pivot of views, a lot depends on how the trade dispute plays out from here. The tariff rates announced on Liberation Day are too self-destructive to stand. It was therefore no surprise that a 90-day pause on most of the highest rates came soon after, and a further carve-out for certain tech items. Expect more unilateral concessions by the Trump administration, though probably dressed up to look like a deal. And if the result is that most countries, including Asia outside China, end up being tariffed at 10% like Australia, New Zealand and the penguins, all that will happen is that US consumers end up paying more. Nobody will shift the location of production for the sake of a 10% tariff, not when the currency of the tariffing nation is already at least 20% overvalued.
The Chinese reaction and escalated bilateral tariffs will be a tougher nut to crack. Clearly the Chinese authorities have assessed that China can outlast the US and withstand the disruption to trade. At these tariff levels, trade between the two nations will simply stop, other than in items already exempted. While US demand for Chinese exports is an important engine of China’s growth, it is not the only one. Autonomous domestic demand in the rest of Asia is becoming at least as big a driver of China’s export growth lately. And together with some inevitable domestic stimulus, this could be enough to ride out the hit to growth while it redirects trade elsewhere. The US, on the other hand, will only have a few months before the pre-tariff rush to build up inventories is depleted, prices spike and shelves start to empty.
It is because we expect the Trump administration to crack and roll back its tariffs further that we see the US as teetering on the brink of recession but not necessarily falling in. Meanwhile, China will again stimulate, including by boosting capacity in advanced manufacturing. This is disinflationary for the rest of the world and – importantly for Australia – when coupled with measures targeting infrastructure and residential property, supportive of iron ore demand. China’s high levels of debt, deflation and sub-national fiscal imbalances are all genuine medium-term challenges. In the short term, though, China looks better placed to muddle through than the US.
The deeper reason for this is that, like Europe, China retains state capacity to respond to challenges, even when the necessary actions are uncomfortable. By contrast, the policy chaos of the Trump administration is in many ways the culmination of a decades-long decline in capacity for collective action. Consider that the President’s power to impose tariffs stems from an Act of Congress. Congress could amend or repeal that Act, but almost certainly won’t.
A consequence of that loss of state capacity – and loss of trust – is the current revulsion phase of market repricing. The tariffs may well be rolled back quickly; if so, some of the current sell-off may prove overdone. Even in that event, though, lasting damage has been done to the US’s reputation as a reliable partner and investment destination. TINA McRAE is out there: a more volatile financial landscape, more diversified and less centred on the US. Asset allocations, hedging strategies and business models will all need to adapt, and soon.
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