U.S. President Donald Trump, left, speaks as Xi Jinping, China's president, looks on during a news conference at the Great Hall of the People in Beijing, China, on Thursday, Nov. 9, 2017. Trump said China is taking advantage of American workers and American companies with unfair trade practices, but he blamed his predecessors in the White House rather than China for allowing the massive U.S. trade deficit to grow. Photographer: Qilai Shen/Bloomberg
For Asian policymakers such as China's president Xi Jinping, US president Donald Trump's behaviour is a flashing red light © Bloomberg

The maddening thing about counterfactuals is that we cannot prove them. We might have a hunch about what would have happened. Maybe the Great Recession would have been a Second Great Depression without QE, or maybe it wouldn’t. Maybe the UK economy would be stronger without the vote to leave the EU, or maybe it wouldn’t.

This week started with a public breakdown of a G7 summit at which Donald Trump refused to sign the communiqué thanks to differences over trade. Outright trade hostilities between the US and Canada, two of the most steadfast allies imaginable, are now possible.

It has ended with the imposition by the US of tariffs on Chinese goods worth $50bn and the declaration by the Chinese authorities that the US has “started a trade war”.

On any analysis, these would seem to be economically alarming events, ratcheting up risk and uncertainty, and threatening harm ahead. After the second world war, trade had steadily expanded decade by decade, arguably until the failure of the Doha Round at the World Trade Organization’s conference at Cancún in 2003. The latest developments suggest that world trade and globalisation stand to go actively into reverse.

Yet it is hard to see any great terror written into markets. Industrial metals prices, directly affected by tariffs, have fallen — as have the share prices of the companies that produce them. But there has been no great panic. The Vix index of volatility, referred to as Wall Street’s fear gauge, remains very low; gold, the ultimate haven, had its biggest fall of the Trump presidency on Friday; bond yields have fallen but remain higher than they were at the beginning of the year.

As for stocks, they had a bad day on Friday but nothing exceptional. For the week, world stocks were on course for a fall of 0.6 per cent (0.3 per cent for US stocks). This is not a great week but certainly not the kind of sell-off we might expect to greet the news that globalisation itself is under threat.

A counterfactual adds another difficulty. We heard from the Federal Reserve this week, and it appeared more determined to press ahead with raising interest rates than many had previously believed. That is quite enough to account for a bad week for stocks all on its own. The news on tariffs may have had no effect at all.

A deeper look at stocks produces one good argument that investors are worried by the trade tensions — and another that suggests they are not.

Global and US stocks peaked in late January. Apart from tech stocks, they are yet to regain that high, or even come particularly close to it. This was despite frankly astonishing earnings numbers in the US. For the first quarter, the S&P 500 companies managed to raise earnings per share by 26.6 per cent year on year, according to Thomson Reuters. Meanwhile, brokers are braced for more good results in the quarter now coming to an end, with predicted earnings growth of 20.2 per cent. Usually, companies cut their guidance as the quarter end approaches and earnings estimates decrease 2 per cent or more. This time around, they have actually risen slightly since the beginning of April.

Prospective earnings multiples, comparing share prices to expected earnings for the next year, are one of the most popular metrics used by traders. If they had merely stayed constant, such huge increases in optimism for corporate profits should have translated into a rallying stock market. It has not happened.

At the turn of this year, the prospective earnings multiple for the S&P 500 was just over 20 — its highest since 2001 when the dotcom bubble was still deflating. It is now trading at only 17.4 times prospective earnings — high but back within normal historic ranges.

This suggests that markets had been priced expecting just the burst of corporate profitability that we have seen, and that the year has seen a significant downward re-rating. Or put differently, the so-so performance of stock markets against such a strong corporate backdrop this year suggests grave concerns, about monetary policy and also quite possibly about trade policy.

Against this, however, we have to look at the performance of different stocks within the market. The winners and losers as trade talk has grown angrier have proved to be almost the opposite of what might have been expected.

Since the market topped in January, the 50 per cent of S&P 500 stocks with the greatest exposure to the US are down 6.2 per cent. The 50 per cent with the greatest reliance on exports are down only 2.7 per cent. So the companies that would be protected by tariffs are performing worse than those who stand to face new tariff barriers (and have also had to deal with a strengthening dollar, which makes them less competitive).

Broadening this, the stocks in the MSCI World index (covering all developed markets) with the greatest exposure to China are where they were at the January top, down only 0.5 per cent. Those with the most exposure to developed markets are down 5.5 per cent.

The pattern is the same over the full period since Mr Trump won election. In the US, exporters have beaten domestic operators by 11 percentage points in that time while, in the developed world, those exposed to China have won by 15 percentage points.

Angst about trade is contributing to problems for emerging markets with EM currencies now their lowest since Mr Trump took office. And we cannot know how investors would be behaving without the noise over trade. But stock market investors are not positioning for a world where tariff barriers are higher and doing business in China is harder.

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