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Forbes: How To Reduce Trump And European Union Breakup Risk, by Steven Dudash

February 27th, 2017 Facebooktwitterlinkedin
Forbes: How To Reduce Trump And European Union Breakup Risk, by Steven Dudash

By Steven Dudash, Contributor

Most have heard the saying, ‘Go big or go home.’ Well, events around the globe could soon have investors thinking, ‘Let’s go small instead.’

The first is trade. Without question, Donald Trump’s White House run was, in part, fueled by his fiery, campaign trail critiques of U.S. trade policy, which he claimed allowed other countries to profit at our expense and spurred the loss of millions of American jobs.

He pledged to change that, promising to renegotiate or scrap existing trade deals and to get tougher on China to swing the pendulum in the other direction. This posture has ramped up concerns that a trade war is in the offing – just as the domestic economy is showing signs of more strength – a prospect that could hamper an untold number of multinationals that depend heavily on unfettered access to foreign markets.

Ordinarily, it’d be easy to chalk up a presidential candidate’s rhetoric as politics as usual or, now that he is president, as a negotiating tactic to win better terms from trade partners. But if there’s one thing we have learned from Trump’s initial days in office, it’s that he’s going to make every effort to follow through on his campaign promises.

In the coming months, then, investors should, at the very least, expect rising tensions with major trade partners. Whether that means tariffs, no one knows for certain, but if that were to happen other countries would surely retaliate with punitive measures of their own, escalating hostilities even further and possibly sparking a full-blown trade war on multiple fronts.

That would put companies that import or produce goods abroad and then bring them back to the U.S. to sell especially at risk. Automakers, which have enjoyed blockbuster sales during the recent run of low-interest rates and cheap gas, are a prime example.

GM, Fiat Chrysler and Ford all import car parts from suppliers with factories in Mexico, while GM and Fiat Chrysler build a large percentage of their trucks – a significant driver of profit for both – there. If Trump were to slap a tariff on these goods, the added costs would get offloaded onto consumers and growth would decline.

The impact would be similar for many other large firms. Wal-Mart, for instance, already struggling to fend off Amazon, relies heavily on cheap manufactured goods produced in China. The same goes for Apple, which is dependent Chinese hardware manufacturers to achieve huge margins. Their prices would go up, and as a result Americans would buy fewer of their products, depressing growth.

Meanwhile, against this backdrop, investors also have to worry about the future viability of the European Union. Over the course of this year, there are a series of elections in Europe that are de facto referendums on whether the EU stays together – including in France, Germany and the Netherlands. Populist forces that favor withdrawal have gained momentum in all three countries.

While presently those forces are expected to fall a bit short, regional politics, as we have learned in the wake of Brexit and Trump’s victory, have become increasingly unpredictable. If another member of the eurozone goes the way of England – with trade wars involving the world’s largest economy simmering in the background – the ripple effects will reverberate around the globe.

And that’s why investors need to ‘go small.’ While large firms won’t go bust, many will have a much harder time achieving growth and producing returns if trade becomes more complicated and the EU begins to disintegrate.

On the other hand, small caps that are far less reliant on international trade or don’t have enough cache or name recognition to draw Trump’s ire will be somewhat more immune to these strains and would be poised to do much better. Think about real estate companies and firms that support infrastructure improvements that are all housed, taxed and provide jobs in America.

Given the fuller macro picture, investors should look to European small caps as well. Though the Dow has pushed through the 20,000-point barrier and markets continue to set new highs, the broader picture is more mixed, colored by full valuations, looming rate hikes and growth rates that lag historical averages.

Even without the added weight of trade-related pressures, it will be a tough slog, with domestic-focused portfolios, in our view, struggling to outpace 3-5% over the next few years. Gaining exposure to smaller European companies that can better fend off the challenges associated with an unraveling EU could help investors improve upon that.

Though it’s always been an unpredictable world, it seems like we have entered an unusually uncertain era, thanks to an uptick in the number of jolting geopolitical events around the globe. Investors should probably expect more of the same for the remainder of this year and adjust their portfolios accordingly.

Article originally published in Forbes:

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