Investment Strategy

Trade War and Peace

 

Everyone is talking about trade. Will there be a trade war? Are we already in one? Why is the U.S. administration pursuing such a hard line with its trading partners? What does it mean for investors?

In understanding the situation, globalization is a good place to start. A gradual reduction in trade barriers over time has led to dramatic increases in interactions between people, companies and governments across geographies, yielding widespread benefits. For developed countries like the United States, consumers have enjoyed access to much more affordable goods, ranging from mobile phones and light bulbs to t-shirts and countertops. For younger economies, globalization has created millions of manufacturing jobs, a key underpinning of their growth in recent decades. But, globalization has also had some costs.

Many believe globalization, and in particular China’s entrance into global supply chains, has contributed to the decline of the American manufacturing economy—and there is reasonably compelling data to support the claim. Cheaper labor abroad incentivized firms to move jobs overseas, while foreign companies were able to flood the U.S. market with cheaper (and often government-subsidized) goods, like the t-shirts and countertops we mentioned earlier.

Why the focus on China?

The current and prior U.S. administrations have viewed some Chinese trade practices as inherently unfair, with the ballooning U.S. trade deficit (particularly with China) becoming a de facto scorecard for trade “fairness,” which is regularly invoked by the current administration. The message has resonated with voters, and the president seems to feel he has a mandate to right the perceived wrongs.

It’s not just about the past, either. The administration has expressed particular ire over China’s “Made in China 2025” plan. In it, China has articulated its goal to achieve supremacy in key technology industries, such as robotics, aerospace and aviation, advanced rail equipment, new energy vehicles and agriculture machinery—in effect challenging the United States for dominance in these areas.

To be clear, it’s not the competition itself the United States takes exception to. Rather, it’s the view that Chinese companies aren’t exactly playing by the same set of rules. Government subsidies, lopsided trade deals that favor domestically produced goods, and other advantages give Chinese companies an “unfair” advantage.

Where do we go from here?

Economists don’t agree on much, but most will tell you a trade war is in nobody’s best interests, and we continue to believe there is a deal to be had between China and the United States, given the strong incentives to avoid an all-out trade war.

But there are also reasons to believe the tension sticks around for a while; with U.S. growth approaching 4% for 2Q, the S&P 500 up more than 25% since the election, recent conciliatory overtures by China and other trading partners, and improving presidential approval ratings, it is hard to see the administration scaling back its full-court press anytime soon.

What does it mean for you?

This is less about GDP and more about sentiment. Uncertainty is having an impact on the premium investors are willing to pay for risk assets. If trade risks fade, stocks can get more expensive, but if they don’t (or get worse), valuations will remain under pressure. With earnings expected to grow by more than 20% in 2018, the fundamentals are there. The question is, what will investors be willing to pay for them?

There are, however, some areas that might be less vulnerable to trade tensions. Though more fully priced, smaller companies in the United States tend to be more domestically focused than large multinational firms. Also, we continue to believe in firms that are returning capital to shareholders through buybacks and dividends, and believe M&A should drive stock-specific performance. Finally, in the event of further escalation, duration (or high-quality fixed income) could help stabilize a portfolio.

For ideas on how to incorporate these views into your portfolio in a way that is suitable for you, we invite you to contact your J.P. Morgan advisor.

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