After months of relative quiet, the trade war (hysterics?) between the U.S. and China erupted again Monday, May 13th in a big way. Since hitting new all-time highs 2 weeks ago the U.S. stock market has fallen over 2%, with the Dow plunging over 600 points on Monday alone. Last week the U.S. announced new tariffs on Chinese imports; in retaliation, China announced new tariffs on some $60 billion of U.S. goods. Many overreacted fearing a widening trade war.
We have discussed trade and tariffs on these pages before, so here is my take on what's going on now:
Economists almost universally want free trade and they understand the dangers of trade wars and tariffs, which are just taxes on consumers. According to Brian Wesbury, “We all run personal trade deficits with a local grocery store and benefit from that. Even if the entire world went to zero tariffs, the U.S. would almost certainly still run trade deficits, even with China. Today the trade deficit with China is partially due to the fact that China has higher tariffs on imports than the U.S. does - working to eliminate these lopsided tariffs is worthwhile.”
You may have noticed that headlines about the trade war have been rather muted in 2019. That’s because negotiators for both nations had been quietly working behind the scenes to come to an agreement on how to address the $375 billion trade deficit the U.S. has with China. The White House expressed optimism that a deal was close – until a sudden hardening of positions prompted both sides to retreat to their corners.
Remember President Reagan's old story supporting free trade? “We're in the same boat with our trading partners,” Reagan said. “If one partner shoots a hole in the boat, does it make sense for the other one to shoot another hole in the boat?” The problem is China hasn't just shot a hole in the boat, they have become pirates. China steals Intellectual Property and R&D from firms located abroad. Some estimates of this collective theft run into the hundreds of billions of dollars annually. That is why normal free-market and free-trade principles don't necessarily apply to bad actors like China.
It is true that tariff increases will not help the US economy. But, $100 billion of tariffs spread over $14 trillion of consumer spending is not a drag likely to produce a recession. While it is true that some businesses like farmers will be hurt, the status quo of hundreds of billions of dollars in piracy from companies that are the leading edge of future growth, to many, is not acceptable.
Last year we exported $180 billion in goods and services to China which is 0.9% of our GDP. Meanwhile China exported $559 billion to the U.S., which is 4.6% of their economy. So it is apparent that the US has tremendous economic leverage that China cannot match. An extended U.S.- China trade battle would likely result in U.S. companies shifting their supply chains out of China toward places like Singapore, Vietnam, & Mexico. If that happens, the Chinese economy would be hurt for decades.
You’ve heard, of course, of the principle of cause and effect. If one thing happens, something else is affected. Investors, analysts, money managers, and traders who participate in the markets on a daily basis make decisions based on cause and effect. How tariffs impact certain companies is a perfect example of this.
The principle of cause and effect is important, but here at Petra Financial Solutions, we rely more on another principle: supply and demand. You see, as investors, we rarely know what the long-term effects of something will be. Too many investors, in fact, rely on pre-conceived narratives to guess at the effects –and guessing isn’t really a viable strategy in life, is it?
The fact is that the markets have fallen after almost every round of tariffs, only to recover a few days later. So, because we can’t really predict the long-term effects of this trade war, we choose to ignore the narratives and focus on what we can control. By using technical analysis, we can look at the various investments in your portfolio to determine whether demand is higher (meaning the price is likely to go up, trade war or not) or whether supply is higher (meaning prices are likely to trend down). We’ll continue making decisions by tracking trends – and trends are driven by many factors, not just what’s in the news on a given day.
Hippocrates once wrote that, “To do nothing is sometimes the best remedy.” For that reason, it’s okay for you to go back to planning your summer vacation or betting which character will die next on Game of Thrones. In the meantime, we will continue monitoring your portfolio. If the dynamics of supply and demand change, we’ll make decisions accordingly.
As always, please let me know if you have any questions or concerns. I’m always happy to speak to you!
Until next time, Cheers!
Jim