Since Britain voted in June 2016 to leave the European Union, its stock market has moved significantly higher. It did not even decline Monday when two prominent ministers resigned from the British government.
Since Britain voted in June 2016 to leave the European Union, its stock market has moved significantly higher. It did not even decline Monday when two prominent ministers resigned from the British government, a protest of Prime Minister Theresa May’s plan to retain a close trading relationship with the European Union after the country leaves the bloc next year. The resignations were a reminder that, should May fail to gain lasting support for her plan, the uncertainty surrounding Britain’s departure could escalate.
But the headline stock market numbers do not tell the whole story. A closer look suggests that the threats to the global trading system are dampening investors’ enthusiasm, and the mood could darken quickly if the fights drag on and start to hurt companies’ profits.
— Brexit concerns are weighing on the pound.
Britain’s two main stock market indexes, the FTSE 100 and FTSE 250, are both up over 20 percent since the June 2016 referendum in which voters chose to leave the European Union, a process known as Brexit. For comparison, Germany’s stock market is up by only slightly more since then.
But stocks do not tell the whole story. Since the Brexit vote, the British pound has plunged 13 percent against the euro, and 11 percent against the dollar. The pound may continue to decline if negotiations between Britain and the EU go badly in the coming months.
The falling pound helps British exporters, because a lower pound makes their goods and services cheaper to foreign buyers, spurring higher sales, at least for a while. But it can also stoke inflation in Britain, by making imports more expensive to British buyers.
Things could get worse if the pound goes into a panicky free fall, because that could stir up fear in other markets and in the wider economy. And that is a possibility, because there is much that could still go wrong in the Brexit negotiations.
May’s plan, outlined last week, is described as a “soft” Brexit because it envisions deep ties with the EU, including the continued application of some of the bloc’s economic rules. Her initiative may have made it easier to reach a deal with the union. Michel Barnier, the bloc’s chief Brexit negotiator, speaking at the Council on Foreign Relations on Tuesday in New York, said: “If they change their red lines, this is their choice, we’ll be immediately in the position to change our position.” He made similar remarks last week.
The sticking point could be Northern Ireland, which is part of Britain. The EU wants Northern Ireland to apply many of the bloc’s rules, to prevent a situation in which a hard border forms between Ireland and Northern Ireland. But this approach may result in Northern Ireland having different rules from the rest of Britain in certain crucial areas, and that arrangement might not be acceptable to many British people, who fear it could divide their country. Ireland’s prime minister, Leo Varadkar, on Tuesday seemed receptive to Britain’s proposal. But once it comes down to negotiating the details, Britain and the EU could still find themselves far apart, and such a stalemate could weigh on the markets.
— Trade war anxiety is a drag on U.S. stocks.
Britain and the European Union, at least, have clear objectives that they are both attempting to reconcile. The same cannot be said of the trade conflicts set off by the United States.
President Donald Trump has imposed or proposed tariffs on imports from the United States’ biggest trading partners, including China and the EU, but it is not engaged in full-fledged negotiations to resolve grievances. Trump’s strategy may be to wait until the economic pain of the U.S. tariffs is felt by other countries, at which point they may be willing to make concessions. But such an approach could prolong the uncertainty in the markets for months.
Superficially, investors might not seem too concerned. The S&P 500 index is up 2.5 percent since the end of February, when Trump announced tariffs on steel and aluminum, his first real shot in the latest trade skirmishes.
But there is reason to believe that stocks would be a lot higher if it were not for the uncertainty surrounding trade tensions.
The U.S. economy is growing relatively quickly, and Wall Street analysts are increasing their profits forecasts for companies. The bullishness about earnings might normally have caused the stock market to rally a lot more than it has this year. One of the reasons stocks are not galloping higher right now is that investors do not know which companies will get hurt by the tariffs, and how bad their financial pain will be. Harley-Davidson last month said it would it would take a hit from tariffs imposed by the EU in response to the United States’ measures.
This week, companies start to release their earnings for the latest quarter. The warnings related to tariffs may occur in unexpected places.
“This is no longer a skirmish, but a global trade war with uncertain consequences,” David Rosenberg, chief economist at Gluskin Sheff, said in an email Wednesday, “but none that are bullish for growth or the investment landscape.”
This article originally appeared in The New York Times.