On the Minds of Investors
Another week, another trade threat?
Ahead of the next round of U.S. tariffs on Chinese imports, U.S. President Donald Trump took to twitter to urge U.S. firms, once again, to move their operations out of China. This suggestion, combined with the threat to leverage the International Emergency Economic Powers Act (a rarely used U.S. law that gives the President broad, but ambiguously defined, powers over the economy) to sanction businesses in China, and to raise the rate of upcoming tariffs by 5%, sets up an autumn full of trade headaches for investors.
Unable to ignore or avoid the uncertainty, equity markets naturally sold off after the news. Markets on Monday—the first trading session for Asia since these threats—proved rocky. At this point, most investors have acknowledged the negative effects of tariffs on both consumer and business confidence, and its resulting impact on spending, and on profits. Given the persistent uncertainty, it is reasonable to ask ‘hasn’t all the bad news from trade been priced in?’ Our view, in short, is that there is more uncertainty to come and investors should be prepared for more trade-linked volatility.
Markets likely have become immune, to some degree, to further increases in U.S. tariffs on imports from China; on this front, continued escalation has become the base case for many investors. Despite the stop-and-start implementation of these policies, tariffs look likely to cover the vast majority of imports from China by the end of the year. The decision to raise the tariff rate on products, in response to China’s retaliation for earlier rounds of tariffs, currently under the 25% rate to 30% and to increase the upcoming 10% group to 15% is unwelcome, but largely does not change the overall picture for business facing these higher costs or for the economy as a whole. We should note that these are public statements by the U.S. administration only, and have not yet been reflected in official U.S. policy. The remaining group of imports, roughly USD 160billion worth, will see their tariff rates rise on December 15.
This delay (the December 15 group was originally set to see higher tariffs as part of the September 1 group), interpreted by some as bowing to the all-mighty U.S. consumer, may actually be a strategy to prolong the trade fight. By avoiding sticker shock around the U.S. holiday shopping season—which lasts from late November to late December, and which retailers build inventories for in October—the administration may have ducked the one-two political punch of angry customers and weak retail sales numbers. If the administration succeeds in doing so, then it will face less political pressure to wrap this trade fight up quickly, if it was ever inclined to do so.
EXHIBIT 1: Average overall U.S. tariff on imports from China
Additional increase in average tariff by round of new tariffs
But it’s not actually all bad news, the U.S. and Japan announced a trade deal that will include increased purchased of U.S. agricultural products and avoid increases in auto tariffs. The auto tariffs element, in particular, removes one of the biggest trade-related worries for Japan investors. The U.S. is still reportedly considering auto tariffs on other countries (a particular risk for Europe). Yet, from media coverage of trade this weekend, investors would barely have seen anything about this development. The fact there is such a high volume of trade news tends to mean only the most dramatic stories get coverage. As the U.S. broadens its threats beyond just tariffs throughout the rest of the year, this is likely to remain the case.
Higher tariffs alone will not successfully decouple the U.S. and Chinese economies. Other proposals, like cutting off Chinese institutions and businesses operating in China from the U.S. financial system and banning exports to Chinese companies or even China, would be far more damaging. While the resumption of talks—as appeared to have occurred early Monday—may put these non-tariff options to rest for the time being, threats formerly cast aside have been picked up again, and enacted, the next time talks broke down. As we have long warned, this trade war is likely to move beyond the application of tariffs and recent threats from the U.S. indicate its strategy is shifting toward doing just that. Unable to avoid trade headlines, U.S. businesses will continue to face margin pressures, global businesses will continue to take a negative outlook on future investment opportunities as evidenced in recent Purchasing Managers' Indexes, and investors will remain anxious. Central banks have also emphasized that while they will act to mitigate the effects of trade, they lack the tools to entirely offset the negative effects of trade wars. Collectively, such conditions likely mean a bumpy last four months of 2019, continued easy monetary policy which will be supportive of equity valuations, and high quality protection, like core government bonds, will likely remain expensive.