Your diligent economic blogger is struggling to keep up with the news on the trade war front. Last week the US and China traded threats of additional proposed trade sanctions – to be imposed after the still-theoretical initial set of mutual tariffs announced earlier in April. Recall that the world’s two largest economies will soon enter a period of trade negotiations, after the U.S. indicated it will impose tariffs on about $50 billion of Chinese goods with a stated goal of reducing the U.S. bilateral trade deficit with China by $100 billion. As of 2017, the U.S. imports a record $375 billion more from China than it exports to that country, accounting for the bulk of the U.S. trade deficit.
The Chinese announced countervailing tariffs on $50 billion of U.S. goods, to be effective whenever the U.S. tariffs are imposed. This action covers about 40% of U.S. exports to China. Notably, the list includes soybeans, which targets American farmers who are presumably more likely to be Trump supporters (8 of the 10 largest soybean exporting states voted for Trump). Tariffs on soybeans will hurt Chinese consumers, which is seen as a sign that China will respond tit-for-tat to any U.S. actions, even at the cost of domestic grumbling.
While last week’s seemingly off-the-cuff threat from the US President and the defiant press conference from the Chinese were increasingly belligerent, nothing is set in stone. The U.S. tariffs have not been enacted yet. There will be a public comment period, followed by a final list of tariffs (taking the comments into account), and finally a 60-day notice period. That would put U.S. tariffs in force toward the end of the summer.
- In the meantime, the back-and-forth in trade talk and posturing could elevate volatility in the equity market through the summer.
Here’s how we at Astor view the trade war scenario, through our lens of economic impact:
There is still time for a vague agreement allowing both sides to declare victory, and that is our central expectation. Even if the currently announced measures were to be the result of the back-and-forth, both economies would likely tick along with only minor losses. - This is the second tariff action Trump has taken this year – the first being a global steel tariff which was quickly whittled down to being focused on China, despite the fairly modest level of Chinese steel imports. The same “big talk, modest action” may be a model for the trade dispute with China as well. On the other hand, the bilateral trade deficit with China is one of Trump’s most consistent positions, so he may not be willing to back down. Especially on his headline catching rhetoric.
- It’s important to note again that the U.S. trade deficit is driven mainly by U.S. savings and investment, and that will almost certainly increase in the years ahead thanks to the recently passed tax cuts and spending increases. A moderate estimate is that the deficit will increase from about 3% of GDP to about 4% of GDP. Similarly the Chinese surplus is mainly a function of domestic economics.
- The stock market is, of course, forward-looking and tends to exaggerate the effects of fundamental information, both up and down. That is, the stock market could be reacting now to the foreseen next move in the trade war. Perhaps more important than the macro effects (which, as we said above, may be modest) are the likely effects on individual companies, which have bet heavily on a seamless cross-border supply chain. That is, new capital will need to be created, old capital will need to be scrapped. Disruption is no fun from the point of view of those who are being disrupted.
- The U.S. economy today is doing well. People are being lured back to the workforce, and industrial production is at a post-recession high. The broad fundamentals of the economy—employment and output trends—are still quite strong for a late-stage expansion. In examining history, we have found that when the economy is strong as it is currently, it is worth investing in the stock market.
- Until we see concrete changes in the positive fundamentals, we will continue to favor exposure to beta, but will remain diligent in monitoring the economic fundamentals with our proprietary Astor Economic Index (AEI).
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