As night follows day, the week rolls by and we find ourselves knee-deep in Friday. Fridays are always excellent days; a gateway to the glorious weekend, heralded as usual by this weeks’ News, Views and Truths.
The eyes of global market participants have been transfixed on both the US and China as a new round of tit-for-tat tariffs has stoked fears of a trade war. The backdrop to this I outlined in a previous edition of the blog, initiated by the desire of D-to-the-onald Trump to “Make America Great Again”.
Although the initial tariffs have been somewhat diluted, with exclusions given to many countries, the UK and EU included, his focus has clearly been centred on China due to their perceived global theft of intellectual property.
So, outlining their plan, the White House detailed its proposals with a 25% duty on Chinese goods, mostly tech and telecom products. In response, Beijing slapped a 25% tariff on $50bn in US goods, including soybeans, corn, airplanes and cars.
As a direct result of this increased uncertainty, the market has enjoyed a rollercoaster ride this week, falling at the beginning by over 3%. Subsequent to that however, the markets have rallied for three straight sessions on the hope that the US and China would negotiate a trade settlement.
All that ended last night, when POTUS stated, “in light of China’s unfair retaliation, I have instructed the USTR to consider whether $100 billion of additional tariffs would be appropriate under section 301 and, if so, to identify the products upon which to impose such tariffs”. That, ladies and gentlemen, is escalation.
As I sit here, the S&P 500 future market is selling off, indicating an opening fall in the index.
But the question I have, is why does the market react in such a way? Why is there such a large reaction to a potential trade war? And let me backdrop this question with the three things you need to bear in mind when discussing the stock market.
- The stock market is not the economy
- The stock market is not the economy
- The stock market is not the economy
Could it be because the trade war is a signal that the protagonists within this affair really are as unhinged and irresponsible as they seem and the markets are taking notice? How would these people handle a financial crisis?
Conventional wisdom would suggest that the effects of a trade war would be a significant reduction in gross domestic product, although these, whilst not trivial, are not usually earthshattering. A greater issue would be that tariffs result in moving your economy away from things that you are relatively good at, to things that you aren’t.
For example, American workers could sew clothes together, instead of importing apparel from Bangladesh; in fact, they would surely produce more pyjamas per person/hour than the Bangladeshis do. But America’s productivity advantage is much bigger in other things, so there’s an efficiency gain, for both economies, in having America concentrate on the things they do best.
And a trade war, by imposing artificial costs such as tariffs on international trade, undoes that productive specialisation, making everyone less efficient.
Going back to the original question, suppose the US were to impose a 30% tariff across the board, with all other countries retaliating in kind so that there is no improvement in US terms of trade, how much would this reduce trade? Calculations suggest that a resulting fall in imports from 15% of GDP to around 5% in turn means a reduction in US real income of around 1.5%, which does not correlate to the significant moves in the stock market.
One reason for the moves could be a tad more cynical. Trade wars are perhaps a catalyst to industry disruption; businesses are forced to evolve, with incumbent dominators within a sector having to evolve or be preyed upon. In the words of economist Paul Krugman, disruption is something, “which business leaders love to celebrate in their rhetoric, but hate when it happens to them.”
But disruption offers significant opportunity for the investor if, that is, you are invested…
Finally and as per usual, we come to our weekly playlist, this week dedicated to those who are going out for a drink, in Durham, tonight. You know who you are. Take it steady, know your limits and get home safely.
I shall see you next week.
