How do stock-market investors even begin to calculate the impact of an entirely different global political hierarchy, a system where decades-old alliances appear to have fallen by the wayside and former allies begin to look more like competitors and rivals?
This is the extreme worst-case scenario that Wall Street analysts have begun to consider over the past couple of weeks, as President Donald Trump has repeatedly assailed allies and cast doubt on the usefulness of alliances like the North Atlantic Treaty Organization.
Market watchers have said that the prospect of any fundamental changes to key alliances would be extremely unlikely — both because it would be difficult to exit an alliance like NATO, and because such a move would undoubtedly face extreme and widespread resistance — but recent events have put the outcome in view in a way that would have seemed unthinkable just a month ago.
“What we’ve seen represent such a departure from our longstanding historical positions with Europe and Russia, and the implications of that remain to be seen. It would be a game changer if we got to the point where NATO broke up. Without question this is something we’re keeping our eye on,” said David Joy, chief market strategist at Ameriprise Financial.
“I think it would be premature to call this a new or sustainable U.S. point of view, at least from the point of view of portfolio implications, but it is startling, and in that respect it certainly catches your attention and bears watching if it shows up in any practical sense” in economic data.
“If you’re concerned about a more contentious world order,” Joy added, “diversification is of paramount importance. As uncertainty rises on the political front, it at least provides some protection.”
The concerns over the stability of alliances between the U.S. and major European countries comes at a time when geopolitical tensions have already been running high, due largely to a recent escalation in uncertainty surrounding trade policy. President Donald Trump’s administration has instituted or threatened tariffs against key trading partners like China and the European Union, and many of these have been met with retaliatory measures.
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Analysts and portfolio managers agreed that the prospect of a trade war was a more immediate concern for a stock market that has recently been advancing on the back of growing corporate profits and strong economic data. However, they noted that Trump’s recent comments against NATO and other allies were likely to exacerbate trade tensions.
Earlier this week, Trump described the European Union as a “foe” of the United States, citing trade policies. He also spoke out against British Prime Minister Theresa May over her “soft” Brexit plan, saying such a tact would “kill” any potential trade deal between the U.S. and the U.K.
He has also repeatedly questioned the point of the NATO alliance, in particular pointing to the military spending levels of other members. In an interview, Trump appeared to dismiss NATO’s Article 5, an agreement of collective defense that has only been invoked once, following the Sept. 11 terrorist attacks in the U.S.
In another political upheaval, Trump gave a joint press briefing with Russian President Vladimir Putin where he embraced Putin’s assertion that Russia did not interfere in the U.S. election, dismissing the consensus view of U.S. intelligence agencies. He subsequently said he had misspoken, though he later said Russia was no longer targeting the U.S., contradicting his director of national intelligence.
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Analysts at JPMorgan last week speculated that there were four possible “endgames” that could explain Trump’s recent actions: “ensuring Republican victory” in the midterm elections by delivering on trade-related campaign promises; containing China’s growing economic and political power; securing China’s assistance with respect to North Korea; and building “a new international economic and security architecture centered on permanent protectionism and isolationism, as foreshadowed by the America First agenda of the 2016 election campaign.”
This final suggestion, the analysts wrote, could entail the U.S. withdrawing from the World Trade Organization. Such a move “would be the most destructive to global markets” of the four possibilities, according to the investment bank, suggesting it would result in “a supply shock that delivers a U.S. recession.”
JPMorgan added, “The conventional wisdom is that this threat too is mere bluster from the country that architected the current international order, so is intended to motivate a reduction in global trade barriers rather than a return to them. But asking the question is no less valid than wondering if Germany would ever exit [the European Monetary Union]. What sounds like anathema today can morph into something sensible the longer a conflict ages and a system fails to deliver its purported benefits.”
While recent developments have shocked political analysts, Wall Street has essentially shrugged. The Dow Jones Industrial Average DJIA, -0.53% has risen for five straight sessions, not including Thursday, and it recently traded at its highest level in about a month. The S&P 500 SPX, -0.40% is trading near its highest levels since early February, and the Nasdaq Composite Index COMP, -0.37% has recently hit records. The Cboe Volatility Index VIX, +5.05% , a proxy for investor anxiety, has tumbled more than 20% thus far this month, and it remains at extremely low levels from a historical perspective.
“The market may be willing to look past rhetoric for now, but if these things continue or deteriorate further, it will really start to influence markets,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott. “What will a further deterioration in relations mean for confidence levels or business spending decisions? There are so many issues that can’t be quickly quantified, but we’re past the point where these things start to become a concern.”
Of course, there is significant distance between comments that may be hostile from concrete measures that would change the global political order even slightly. And in the event that such steps were initiated, it would be extremely difficult for anything to come to fruition.
As a measure of the kind of bipartisan support for NATO and against Russia, the U.S. Senate earlier this month overwhelming voted in favor of a motion supporting NATO, while Senate Majority Leader Mitch McConnell floated the idea of targeting Russia with more sanctions.
Nevertheless, should Trump continue to speak against NATO, that could impact the already rattled confidence of investors.
“Trump’s comments aren’t seen as important in terms of driving market sentiment. At this stage, the high level of geopolitical uncertainty doesn’t change the investment outlook, whereas the threat of a trade war does,” said Lee Ferridge, head of macro strategy for North America at State Street Bank.
“Of course, calling the EU a ‘foe’ doesn’t lower the expectation that a trade war will escalate. The kind of rhetoric we’ve been seeing makes people think things will deteriorate further on the trade front. Even if political alliances deteriorated, that would show up in trade, with tariffs and sanctions. That’s the impact. For the markets, NATO is a trade issue.”