Markets have farther to fall if Trump won't back down on trade: Don Pittis

Business leaders have repeatedly warned that U.S.President Donald Trump's global trade war will hurt, not help, most U.S. companies. So why haven't we seen markets swoon?

Yesterday, many shares, including automotive companies,were down sharply. Asian stocks fell too as the U.S. and China upped their trade war threats. But some experts say if U.S. trade threats goahead, we ain't seen nothing yet.

There are at least two important reasons why it is worth trying tounderstand how markets are reacting to the growing protectionist threat.

Canary in the coal mine

As a signal of expectations, markets can act as a canary in the coal mine. A mild reaction is an indication there is little to worry about.

On the other hand, a sharp decline wouldoffera crediblewarning about the dangers of a full-blown trade war that would concentrate the minds of those in the U.S. government who have the power to oppose Trump's plans.

The second considerationis to think about what signalswould actually convince market traders that the world has crossed into the danger zone. In other words,what would make markets sit up and take notice?

The first possibility that has to be addressedis that markets have been correct in thinking that it's all just empty rhetoric and there's nothingto worry about, says Ambrus Kecskes, a specialist in howfinancial markets interact with the real economy at York University's SchulichSchool of Business.

Markets are often correct in making forecasts, but as we saw in the 2007 sub-prime crisis and the 2014 oil crash, sometimes they are not.

Spectacularly wrong?

"At any point in time on any particular issue, like the next couple of months' impact of these escalating trade tensions, markets can very well be spectacularly wrong," says Kecskes.

Thereis a longlist of otherpotential reasons why investors are not "fleeing the stock market" as the New York Times put it this week.

One is that many market traders could be convinced that Trump's protectionist measures won't hurt the U.S.

Kecskesand Bill Anderson at the University ofWindsor's Cross-Border Institute say that is naive.

They say auto tariffs alone, which according to a TD report this week would "cost Canada 160,000 jobs,"would also lead to a rout in U.S. automotive stocks and damage related industries that serve the car business.

A cure that kills the patient

"The question is whether, from the American perspective, the treatment would kill the patient," quips Anderson in his native Boston accent.

As a single example, he cites a newly builtbillion-dollar plant in Windsor that makes vehicles for the U.S. market. Spending all the money a second timeto reconstruct Canadian and Mexicaninfrastructureon the U.S. side of the border could simplybefatal for the U.S. car companies.

In the years while the U.S. industry struggledto rebuild or simply raise prices to cover theduty on parts it could not yet make at home foreign competitors would beinvesting in better and cheaper cars.

As Trump has often complained, North American-madecars mostly sell in North America. But asKecskespoints out, for other companies it's different.

"Bear in mind in all these discussion, thatabout half of the S&P's earnings come from outside the U.S."

Failure to invest

Kecskes says a real trade war as envisioned by Trump would slash U.S. gross domestic productwhich, perversely, might reassure market traders who fear rising interest rates.

• U.S. protectionism would harmCanada, Mexico: Scotiabank

Another reason markets have yet to respond is what might be called thedelay effect. While steel and aluminum tariffs are in place now, for example, there is a lag before shortages or price rises hit earnings. That is what happened in the U.S. construction industry after the U.S. imposed tariffs on Canadian drywall.

Of course, earnings are the hard financial indicator of how a company has responded to any trade shock, but Kecskessays in markets, earnings are actually an indicationthe damage has already been done.

"Where you're going to see this in advance is in business confidence," says Kecskes.

If business leaders become convinced the Trump-led trade war is escalating, they may be forced to reconsider whether they should rein in new investments abroad, or how they should adjust to the new tariff regime.

"If you're an American steel producer, you've got to figure there's a least a 50-50 chance that somebody else is eventually going to get to be president of the United States and the tariffs are going to go away," says the Cross-Border Institute's Anderson.

"So are you going to sink a huge amount of money into plant and equipment for an advantage that many be ephemeral?"

Follow Don on Twitter @don_pittis