The US-China Trade War: The Dragon Bites Back

May 23, 2019 | Richard So


What does the ongoing trade war mean for your portfolio?

Last week, the Trump administration hiked the tariff rate to 25% on $200 billion worth of Chinese goods. After that weekend, China retaliated by imposing its own tariffs on $60 billion worth of American goods.

At first glance, it looks like an undersized retaliatory move (“only $60 billion?”). The underwhelming number stems from the fact that China simply imports less goods from America than vice versa, and thus they have less capacity to enact the same damage using tariffs. After all, the disparity in the value of goods traded is exactly the point of contention in Trump’s “trade war”.

Who will make the next move?

Although it is difficult to quantify the impact of this tariff hike, some analysts at RBC Capital Markets estimate that it will cost the US economy around 0.5% of GDP (not an insignificant figure, but still insufficient to induce a recession). There is now uncertainty regarding which levers China could pull in retaliation, which could further escalate this conflict. Some have suggested that China could seek to devalue their currency in a bid to make their exports more attractive, thereby helping offset the impact of tariffs. We believe China will tread lightly with this approach, as it could trigger capital outflows and damage their efforts to keep China’s economy perceivably “open.” Others have suggested that China may dump the $1 trillion dollars of US Treasuries, but this would result in damaging their own balance sheets. Finally, Chinese boycotts and government interference with iconic American brands (Nike, Starbucks, Apple) could also be used; However, this could cause significant self-harm, since these companies are such large employers of Chinese workers, and are largely integrated into local Chinese businesses as part of the operating and supply chain. Although we can never preclude China from engaging these strategies, doing so comes at a cost, and places natural limits on the lengths to which they will go.

In terms of timing, we recognize that this is actually the opportune moment for Trump to go on the offensive against China. His re-election campaign is still in the distant-enough future that this is arguably the best possible time to “poke the dragon.” Trump has the benefit of an impressive GDP print at 3.2% growth, a low unemployment print of 3.6%, a successful Q1 Earnings season that massively beat expectations, and the stock market has recently reached all-time highs. If one had to go on the offensive, it is always wise to do so from a position of strength.

Undoubtedly, tariffs are widely understood by economists to be an inefficient tool, since it reduces global trade and efficiency. However, there appears to be growing support by ordinary citizens, business executives, and politicians on both sides of the aisle, for the US to continue to use this tool as a negotiating tactic. Being “tough on China” is required to maintain America’s global standing and secure a fair playing field for future business. Even though it is Americans who effectively bear the weight of these higher tariffs, by paying for imported goods at an inflated price, it does make US-produced goods more price-competitive. At best, it could encourage corporations to move production facilities back home, or at least incentivize production to move to different emerging market countries. Hence, although increasing tariffs are economically detrimental to both countries, it hurts China more, and that’s perceived to be a good enough reason as any to go ahead with tariffs. (Note: US exports to China account for less than 1% of US GDP and US imports from China are roughly 2.6% of GDP ).

Making the “right” investment decisions for you

In hindsight, we may see this period as a routine pullback, however we don’t belittle the volatility that investors are currently experiencing. In these moments, we recognize there are two ways to manage money, and both are equally valid in our view.

The first is to “stay the course,” and this is most fitting for those long-investors who can stomach the volatility. Like most periods of market uncertainty, these investors recognize that the long-term prospects for the market are intact, and the bigger risk is to sell stocks and potentially miss participating in the recovery. An eventual recovery is rationalized by looking at the fundamental drivers of the market: solid economic growth, strong corporate earnings, a Fed who has suspended interest rate increases, and a President who appears to want to positively influence stock market performance as the 2020 elections approach. Whether it is just a joke or not, it really does seem like we are only one tweet away from a recovery, and this President needs a healthy market and economy.

The second strategy is to de-risk the portfolio by selling stocks, with the acceptance that a recovery could be missed. Although the current consensus is that this tariff retaliation will not be the beginning of a new leg lower for stock markets, there is a real re-emergence of uncertainty, as trade tension have escalated. Investors cannot be faulted for wanting to reposition some of their profits from 2019 to the sidelines to take a breather.

Investors need to recognize that being “right” about the market cannot always be measured objectively. Objectively speaking, the action that provides the highest return is “right.” However, most investors have the inherent need to be able to sleep well at night, and although that may not lead to the highest returns, a portfolio action that leads to missing some returns may actually be the “right” move for you. At this point of the cycle, it is imperative to review your goals and your tolerance for risk with your advisor. Linking your investment plan with a professional financial and retirement plan will help you make the “right” decision for you.


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