16 May 2019
The US / China trade dispute has been reignited by President Trump in recent days, but GAM Investments’ Charles Hepworth wonders whether the resultant market distress is justified.
It is becoming increasingly obvious that the louder President Donald Trump tweets, the more the level of untruth. His latest Twitter firestorm, which eggs on the US Federal Reserve (Fed) to “match” whatever China does in reaction to the tariff impositions, is a bit left field even for him – cutting rates and redeploying QE (quantitative easing) is not what the doctor ordered at this stage of the cycle, in our opinion. With Trump claiming that the US will win the upper hand in any negotiated trade deal, this supports the increasing odds that a resolution may not be in the offing – China might simply decide to wait Trump out until next year’s election cycle. This, however, could be seen as a worrying development as the expectation of an agreed trade deal buoyed strong market returns so far this year. But as much as the tariffs are not the best development – have they really justified the equity market distress over the last week or so?
Tariffs are additional costs borne by consumers of the importing country – in this case the US. Trump hiked tariffs on USD 200 billion worth of Chinese goods last week from 10% to 25%, therefore raising an additional USD 30 billion in “taxes”. Should he decide to tariff all imported Chinese goods at 25%, this would raise a combined total of USD 135 billion a year – this sounds a lot but it is actually small fry compared to the total US tax bill of over USD 5 trillion. We believe the effect it will have on inflation will be transitory but immediate – it could boost consumer prices by 0.3% to 0.5% or so. That may be enough to push the Fed into a more hawkish stance again and reverse from their previous policy reversal. In turn, businesses would feel more of a hit with an estimated 1% cost increase according to a Fed study.
The trade war development is clearly not ideal – trade fights between the world’s two largest economies are not conducive to an acceleration of global growth which is what was hoped for this year, but we feel it in no way justified the market wobble witnessed. We are now seeing moderate rallies return as the ‘hotter’ money exits stage left. China’s economy was already slowing before this trade spat, as evidenced by the latest batch of economic data released, which showed a slowdown in all parts of its economy. As China evolves to a more developed nation from developing, we believe the natural rate of growth will slow. I would expect China to accept the tariff status quo as it still affords them the points that the US-China hawks protest most about: joint ventures which they state leads to intellectual property theft; and state subsidies that give an unfair advantage. When the US was industrialising in the 1800s, it operated the same domestic protectionism and this is why we believe China might never agree to US demands, whatever the cost. We expect stimulus from China to come in response to their slowing economy and the effects of the tariffs and, with that, a return of risk-on investor behaviour.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.