Here’s the biggest threat to our bull market that most investors are overlooking

It’s not spiking bond yields, Chinese growth or burgeoning debt that poses the greatest and nearest term risk to our two-year bull market.

The greatest threat is probably something you have not even thought much about. That is going to change as the US moved a lot closer to triggering a trade war with China after the US Commerce Department released its recommendations on imposing tariffs and quotas on imported steel and aluminium.

Any trade war between our most important strategic and economic partners is going to cost us big as Australia will be caught in the crossfire.

One of the first places we will feel the pain is in our equity markets and that is why investors should be concerned that the US Commerce Department is using “national security” as the rationale for pursing President Donald Trump’s protectionist agenda as it allows the president to bypass congress in imposing harsh restrictions on those imports.

You can expect a tit-for-tat response from the Chinese and it’s miners like Rio Tinto Limited (ASX: RIO) and South32 (ASX: S32) that will take the first blow as a trade war will severely curtail demand for our hard commodities, particularly alumina and iron ore.

Ironically, the news sent metal prices jumping higher on Friday with aluminium leading the charge with a 2% gain on fears US manufacturers will lose access to cheaper steel and aluminium.

But Australia sells most of its raw materials to China so the higher commodity price will be more than offset by lower production from falling demand.

What’s worse is that the pain will spread in at least two ways. The first is the impact on global economic growth – the key reason used to justify the rally in global equity markets, including the S&P/ASX 200 (Index:^AXJO) (ASX:XJO).

Slowing global and Chinese growth will significantly impact on Australia’s gross domestic product (GDP) while inflationary pressures build from a trade war.

It was the higher inflation reading in the US late last week that sparked the most recent rise in bond yields, which hung over our market.

Inflation will definitely rise further if a trade war breaks out and that means higher borrowing costs for everyone.

Slowing growth and escalating inflation is the recipe for the dreaded “S” word – stagflation. A period of low to no economic growth and high inflation will be a devastating outcome for our share portfolio and the wider economy.

This means all blue-chips will suffer from our landmark financial institutions like Commonwealth Bank of Australia (ASX: CBA) and Macquarie Group Ltd (ASX: MQG) to our favourite industrials like CSL Limited (ASX: CSL), Cimic Group Ltd (ASX: CIM) and Treasury Wine Estates Ltd (ASX: TWE).

A trade war could still be averted and the latest move by the US Commerce Department may be nothing more than manoeuvring to give President Trump an edge in trade negotiations.

However, investors should pay very close attention to this issue from now on. I will be closing most, if not all, of my equity positions if a trade war breaks out.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited, Rio Tinto Ltd., and South32 Ltd. The Motley Fool Australia has recommended Treasury Wine Estates Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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