Trade War? More Like Trade Row.

April 6, 2018 Ian Taylor

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On Monday, China imposed tariffs on 128 American products—including wine, pork and pipes—in response to President Trump’s announced plans to implement 25% tariffs on US$60 billion of Chinese imports. Since then, news of a potential trade war has made the front page of The New York Times every day, as the two countries continue to exchange threats of new and increased levies.

American businesses caught in the crosshairs, such as vintners in California and soybean and pork producers in the Midwest, are rightfully concerned about the potential for lost revenue. But the outlook for investors is less worrying, even despite recent market volatility.

We’ve followed trade dynamics between the U.S. and China closely since President Trump’s election. At this time, we are confident that the global economy can absorb these new tariffs without significant disruption to what is an overall positive growth story in 2018.

Investors’ concerns aren’t limited to tariffs

The evolving tariff dialogue between the White House and China seems to be making investors nervous, judging by the market dips that follow every new development. But at least in March, tariffs weren’t the only driving force behind the market’s reaction.

Investors were fielding several different risks at the same time: Facebook’s increased regulatory scrutiny; the Fed’s recent interest rate hike, and the more confident tone they used to deliver the news; and early signs of slowing economic growth in Europe and Japan.

But it’s worth noting that even with all this uncertainty, it didn’t take long for markets to recover lost ground. And subsequent drops have also been short-lived.

We believe that some volatility will persist as markets digest higher interest rates. But a recession over the next 12 months seems very unlikely. First, U.S. fiscal policy is set to expand over that time. Moreover, growth in the Eurozone remains above potential amid still very easy monetary policy, and Chinese economic growth remains stable, as well.

U.S. tariffs are a response to supposed trade malpractice

The tariffs on Chinese imports that President Trump announced in March, accounting for US$15 billion in total, were a measured and specific response to allegations of China’s unfair trade practices. Many American companies contend that China has repeatedly violated intellectual property rights in the course of its economic transition over the last 20 years driven by industrial manufacturing and now moving to one more driven by consumer goods and services.

Thus, the proposed U.S. tariffs target companies in aerospace; biomedicine; and information technology, machinery and robotics—all industries China is striving to lead as part of its “Made in China 2025” plan.

But what about the direct impact to the U.S. economy? US$15 billion might sound like a large number, but according to our research providers, it could have been as high as US$50 billion. So in our view, the US$15 billion figure was a positive surprise.  The news today that President Trump is considering further tariffs on up to US$100 billion of imports from China would lift that number closer to the $50 billion estimate.

Either way, these tariffs represent only a small percentage of the US$528 billion the U.S. imports from China (the initial tariffs represent about 2.8% overall). In addition, because the U.S. is less reliant on trade than China, they have less to lose—at least in the near-term.

The proposed tariffs may only affect China at the margin as well. Its economic output last year was approximately US$12 trillion, and is expected to grow by another 6.5% (adjusted for inflation) this year. So the proposed duties amount to just ~0.1% of the overall Chinese economy, not including China’s future attempts to offset the economic impact, which are practically guaranteed.

The tariff take home message

While the economic impact of such tariffs is small, the message President Trump sends along with them is clear: the U.S. will not hesitate to take action if China continues to ignore international trade rules. As an aside, China has not admitted any wrongdoing.

China has said it is prepared to respond in kind unless the U.S. changes tack. But Chinese officials have also expressed a desire to engage in rational discussion rather than escalate this spat into an all-out trade war. We will continue to keep a close eye on both countries’ actions in order to assess whether they present a significant risk to the global economy.

Longer-term, the U.S.-China theme will be important for capital markets. The expanding (and transforming) Chinese economy presents a real opportunity for global investors.

At the same time, China’s growing economic clout might eventually challenge the U.S.’s position as the world’s leading economic power. But it will remain in both countries’ best interests to foster growth domestically and abroad.

Through our network of partner firms, MD has access to deep geopolitical research and we review it regularly and with care, especially in light of recent events. Just today I was speaking with Gary Evans, Senior Vice President and Head of Global Asset Allocation at BCA Research, a firm with almost 70 years experience researching capital markets and one of our trusted advisors. He agrees that the U.S. fiscal stimulus just announced far outweighs the economic impact of tariffs proposed by the U.S. and China.

So, while there is room for escalation, the data so far suggest that the U.S.-China trade row will not derail what is at base a steadily growing global economy—a welcome reassurance for investors.

 

About the Author

Ian Taylor

Ian Taylor, CFA, CIM, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees strategic and tactical asset allocation mandates, alternative investment mutual funds and is a member of MD’s Tactical and Risk Allocation Committee.

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