We have been sitting tight on our portfolio asset allocation since the beginning of the trade war escalation this month. Does this mean we aren’t worried? For now, the answer is, “Yes, unless.”
The outlook for US/China trade relations is unsettled. The US could be at the beginning of a long drawn out trade war, or we could see some form of agreement between the US and China emerge in the coming months. Every day seems to change the outlook.
The good news last week was that President Trump delayed auto tariffs on the European Union and removed steel and aluminum tariffs on Canada and Mexico, so the administration could focus on the US/China battlefront. At the same time, the outlook for a US/China trade agreement worsened as rhetoric escalated and the two sides dug in.
Both the US and China can weather a trade war for some time (the US has the Federal Reserve on pause keeping interest rates low, while China has the ability to stimulate its economy on a number of fronts.) Unfortunately, the public nature of the negotiations exposes the vulnerability of both President Trump and Secretary Xi Jinping to appearing ineffective. When it comes to negotiated settlements, a deal that leaves one side the clear winner and the other side the obvious loser is not viable. Each leader must walk away with sufficient terms in an agreement to meet with approval back home. And that may take time to mediate.
In the meantime, tariffs are having an increasing impact on the global economy. There is general agreement that tariffs can stifle global economic growth, increase prices and restrain consumer purchasing power. (See my colleague Derek Amey’s May 15,2019 blog Tariffs Explained.) Secondary negative effects can be felt from the potential of a rising dollar, higher inflation, slower capital investment and increasing uncertainty. The bet is that if major tariffs are used only as a short-term pressure tactic to force an improved trade agreement for the US and better protections for our technology, then the outcome is worth the temporary pain. The danger is that the short-term pain continues long enough to become a catalyst for a more severe economic downturn. We don’t believe we’re near that point yet, and there is much hope that such a negative impact can be avoided. Still, anxiety is rising.
Our Portfolio Management Committee spends a lot of time reading independent research scoring the odds of what happens next. Here are a few, selective quotes from some of our major research resources.
BCA Research: (5/20/19) “Temporary barriers to free trade, implemented as a negotiation tactic, are not a big deal for equities. A significant rollback to globalization, however, and a need to divert global supply chains away from China could stop the bull market in its tracks.”
Strategas (5/9/19): 25% chance for either a complete deal or agreement in principal reached in the near term with tariffs eliminated or substantially reduced; 15% chance that the talks totally collapse and tariffs escalate; and 60% chance of continued negotiations with possible improvement but some form of tariffs remaining in place.
Ned Davis Research: (5/14/19) “Recent estimates from the Tax Foundation suggest that all imposed and announced tariffs (most of which are on trade with China) will subtract 0.75% from long-run GDP, will reduce wages, and will cost more than a half million jobs.”
Barron’s: (5/19/19) “Both the US and China are in a better economic position to withstand the latest tariffs. And the Federal Reserve and other accommodative central banks offer markets a cushion. Changing trade patterns, meanwhile, could reduce the impact of the trade dispute on the global economy.”
For investors, the key is how long the stand-off lasts and what adjustments various countries and businesses make to the increasing costs of tariffs. Right now, markets are priced for a delay – not derailment – in a trade settlement. The temporary imposition of tariffs, while hard on certain segments of our society, will likely slow but not thwart economic growth. Still, in the near-term markets could remain volatile, impacting global risk assets. We wouldn’t even be surprised if the markets, through a significant slide, try to force the two sides to reach some interim acceptable interim arrangement.
That means that cautious investors should remain cautions while longer term investors should give the negotiations a chance to play themselves out. At the same time, we are mindful that the future may call for more active portfolio adjustments as geopolitical pressures define and redefine themselves over the coming months.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.