Trade policy uncertainty shocks and the second Trump administration

It's here already

Remember when people were arguing for the inevitability of a US recession in 2023? We did not get one in 2024 either. Outright recession calls will likely be conspicuous by their absence in the turn-of-the-year macro outlooks for 2025, but that should make us more nervous, not less.

Ruchir Sharma had a piece in the FT claiming:

America is over-owned, overvalued and overhyped to a degree never seen before. As with all bubbles, it is hard to know when this one will deflate, or what will trigger its decline.

This is very similar to the ‘end of dollar dominance’ narratives that claim the US must come unstuck eventually and point to all the things that could potentially go wrong, but somehow never do. There is an element of anti-Americanism in some of these narratives, which is why you tend to hear them coming more from the FT and European economists. If you do not like America for whatever reason, then it is psychologically harder to like US dollar assets, but indulging that prejudice has been very expensive for a long time now.

‘Bubble’ claims are mostly analytically and empirically empty, but there is no doubt that US equities are expensive in absolute and relative terms. The outperformance with respect to Europe in 2024 is more pronounced than in any year since 1976, based on a BoA chart doing the rounds this week. This has the value contrarians trying to make the case for Europe and China but they run into the obvious difficulty that the US is outperforming in terms of underlying fundamentals, even if you think equity prices are rich relative to those fundamentals.

Whether it is GDP or productivity, the US has consistently outperformed much of the developed world in aggregate over an extended period. It is easy to make the case for the relative outperformance of US equities, even if you think absolute valuations look stretched. People like to speculate about what could go wrong with the US in the future, eliding what is going wrong in other economies right now. Adding to the list of favourable fundamentals, US corporate profits as a share of GDP are at record highs and well above long-term averages. That would seem very relevant to the valuation of US equities.

A version of the following chart has been kicked around a lot in Australian economic commentary circles in recent weeks, variously rebased to show the underperformance of Australian real gross household disposable income per capita relative to peer economies. Australia’s recent underperformance has been rationalised in various ways. A more interesting perspective comes from rebasing to the beginning of the series, which shows the US outperforming the G7 and OECD for the better part of a decade.