Trade War – the Tariffs
It took some time for investors to finally shake off their complacency and show their discomfort with the reality of higher tariffs. The mid-June headlines indicating the U.S. would impose $50 billion of tariffs on Chinese exports helped end their lethargy. In fact, on July 1st only $34 billion will be implemented and principally on agricultural and industrial machinery. The remainder of the increase—partially on semi-conductors– will be delayed and subject to future hearings. China responded with similar tariff amounts primarily on U.S. agricultural products. The recent trend of soybean futures (figure 1) shows traders anticipated that move.
More Tariffs and China’s Possible Response
After the mid-June announcement, the administration further threatened to impose higher tariffs on roughly $450 billion of the $506 billion imported from China in 2017. At the same time, China imported just $130 billion of U.S. goods. So obviously, the administration senses that China cannot respond proportionately to its tariff threats. However, China could respond by making it more difficult for American companies doing business in China. Other tactics China could adopt include weakening the yuan or, less likely, threatening to reduce its holdings of U.S. government debt. The recent decline of the yuan suggests an adjustment already occurred (see figure 2.)
Source: Daily Shot
The Real U.S. Concerns—Not Trade—China’s Technological and Military Accent
The administration’s underlying concerns center on China’s rapid advancement of its military and technological strategies and goals. The administration threatened tariffs in attempt to negotiate a limit on China’s access to U.S. corporate intellectual property particularly technology. The administration also used the same threat to attempt to make it easier for U.S. corporations to operate in China without ultimately fully sharing their proprietary operating and manufacturing systems. At this point, not surprisingly, China shows little willingness to respond to these broadcasted threats.
A More Immediate Threat—NAFTA Negotiations
While investors focus on trade issues with China, an immediate threat may come from the NAFTA negotiations. The key date comes up at the end of this week. On July 1, Mexico holds its presidential elections and polls call for the election of the populist candidate Andres Manuel Lopez Obrador known by his acronym AMLO. Assuming NAFTA negotiations do not succeed by June 30, his election would undoubtedly put off further any possible NAFTA restructuring agreement. With that, easy congressional fast track approval will be delayed. Ironically, the election of AMLO pits two populist presidents on opposite sides of these negotiations—AMLO and trump. With the upcoming mid-term congressional elections, the white house might live up to its past threats and withdraw from NATFA.
Despite the trade war issues, we expect ultimately that world leaders will face up to the need to solve some of the legitimate concerns of this administration. Perhaps, weaker financial markets and stress on their economies will push through an ultimate agreement. Alternatively, with the president’s known focus on stock market performance, the evident investor displeasure with his trade fight may move him to a more conciliatory position. At the end, it takes two to tango. So far, no one showed up at this dance.
With that expectation, we remain of the opinion that the fed’s normalization policies will prove the most important force effecting financial markets this year and next. If that proves the case, our view remains that fed normalization efforts will cap stock multiples. Therefore, companies that can demonstrate above average earnings growth will benefit. If these stocks suffer from the trade whirlpool, investors should use that opportunity to initiate or add to growth stock positions.
Andrew J. Melnick, CFA
Chief Investment Strategist
First Capital Investment Partners