Talk About Trade
The majority of the market questions we’ve received over the last three months have been on trade. The back and forth between the White House and China (and most recently, Canada and Mexico) have some of you biting your nails and reaching out. As always, we feel privileged to play the role of interpreter and trusted advisor during these uncertain times.
Frequent changes to international trade restrictions set forth by the administration have made this article nearly impossible to write and have it stay relevant. We started it in early June, only to have rewritten it 7 or 8 times since. At the time we put a stamp on it, the White House has proposed a 10% tariff on $200 billion of Chinese imports, up to $400 billion if China retaliates. This is atop the 25% tariff on $50 billion of international imports announced earlier this year. The administration has stated the tariffs will boost the economy, protect American business interests and shore up national security.
While the US is the 2nd largest exporter of goods and services (China is the first) as a percentage of our gross domestic product (GDP), our exports are lower than most other countries. In fact, China does not have enough imports from the US to counter the tariff threat entirely (the US only sold $130 billion of goods to China last year; China sold a little over $505 billion to the US). However, they do have other opportunities such as increasing regulatory inspections or delaying licenses which would make exporting to them more difficult.
Are we heading for a trade war?
We agree with the overarching consensus that there is room and time for compromise. In cases around trade, the pattern of the White House has been to start with a threat then negotiate from there. A negotiated trade environment could prove to not only ease tension and fears of investors, but in fact boost confidence and market returns.
What will be the biggest impact if these tariffs go through?
At some point, increased tariffs will probably hit the consumer and their pocketbook.
You’ll remember a few months ago, the administration proposed a 25% tariff on $50 billion of imports on steel and aluminum. Only about 1% of it focused on consumer goods and it mostly applied to businesses: semiconductors, plastics, machinery, etc. With the new $200 billion threat, it will be near impossible for the list of items tariffed not to include consumer goods. Cellphones (of which Americans bought $70.4 billion worth in 2017) and computers ($45.5 billion worth bought last year) are the top imports that would be impacted. Are we willing to pay a bit more for an iPhone or computer? Economists think so.
But price increases aren’t the biggest concern that comes with these tariff threats. The larger impact could be the dampening effect tariffs would have on the US economy. If China responded in kind, economic growth in the US could slow by 0.3% next year which could more than wipe out proposed economic gains from the recent tax reform bill. This may not seem like much today, but compounded over time, it could have a big impact.
How could tariffs slow the economy?
Barring government subsidies, if a company imports materials that are now more expensive due to tariffs, its profit margins will go down. Lower profit margins will put a damper on hiring new employees, wage increases, business expansion, etc. A company could try to counter lower profit margins by increasing its prices, which then makes their product less attractive, resulting in lower sales. The same result happens with an importer of our goods puts a tariff on us. Higher prices typically result in lower sales.
Whether all of this comes to fruition or not, just the thought of it can make companies pause and lose confidence about what the future may look like. The markets don’t like it when businesses lose confidence. Just after the announcement of the new tariff threat, the stock market dipped about -1% for that very reason.
So, what’s my takeaway?
With nearly half of the profits from the companies on the big stock indexes reliant on international trade, we expect we’ll continue to see this kind of volatility over the next few weeks, particularly as we approach the July 6 implementation date for these first round of tariffs, and throughout the summer as negotiations continue.
At the moment, economic growth estimates are strong at nearly 3% for the full year which is encouraging. Economic fundamentals have been the cornerstone of what appears steady in our forecasts; however, there are several headwinds out there. Next month will be the 9th anniversary of our bull market, interest rates are rising and we are well aware of where we’re at in the economic cycle.
It’s possible that in a year, the US will be in a very different position in regards to its global standing, but we don’t know yet. The 24 hour news cycle allows commentators to speculate based on the scraps of information they’re given, commenting on the flashiest headlines. As you know, we don’t make investment decisions based on the headlines, the administration or uncertainty. We make them on sound planning and wealth management principals.
It’s important to keep this in perspective. Markets are still near an all-time high. Volatility of plus or minus 1% in a given day is very normal. As always, we recommend that you keep cash for your short term needs (next 12 months) out of the market. If you’re still worrying, give us a call. Let’s talk about it.
For our detailed quarterly economic commentary and portfolio overview, click here.