If there is one thing that is predictable about President Trump, it is his unpredictability. A few weeks ago, China and the US appeared to be close to signing a deal, drawing a line under the trade war that has been troubling markets for much of the past year.
But that was before the president tweeted plans to raise, rather than drop, tariffs on billions of dollars of US imports from China: a threat trade representative Robert Lighthizer justified by claiming Chinese negotiators had backtracked on provisions the US thought had already been settled.
That threat was followed through on Friday 10 May when the US more than doubled tariffs on $200bn of Chinese goods, prompting threats of retaliation from Beijing. The US disregarded these threats and began work on tariffs covering a further $300bn imports, which would leave almost all Chinese goods suffering levies.
The escalation of tensions has raised the prospect that talks between the US and China could collapse entirely. Investors got a taster of what could follow as equity markets tumbled in the days after the president’s tweet.
On the US markets, the damage wasn’t limited to industries sensitive to the Chinese market, such as semiconductors and farming. Stocks fell across the board, including those in smaller, more domestically oriented companies.
The message from investors was clear: an all-out trade war could do serious damage to US, Chinese and global growth – let’s not go there.
Out in the open
Yet, while the tariff volte-face took markets by surprise, on reflection the tactics on display came straight out of the Donald Trump playbook. It is just the latest example of the president publicly using tactics that under another administration might well have been employed behind the scenes.
In all likelihood, the latest move is simply a negotiating ploy to extract more concessions from the Chinese camp, albeit a dangerous one. While there is no denying that the threat of a full-scale trade war has increased, we believe that the chances of it happening are still relatively low.
There is inevitably a degree of playing to the cameras – or the social media equivalent – in the stance of the president, who has long railed against China and its trade relationship with the US. On the campaign trail Mr Trump called the US-China trade deficit, in typically understated style, “the greatest theft in the history of the world”.
Playing to the hawks
Acting tough plays well to Americans who believe that tariffs are a way to rebalance trade with China and restore American manufacturing jobs. Indeed, Mr Trump has tended to publicly side with the China trade hawks in his circle, declaring in a December tweet: “I am a Tariff Man”. For such hawks, led by White House trade adviser Peter Navarro, tariffs are a way to force China to deal with long-standing areas of contention like intellectual property theft and American access to Chinese markets.
So, who pays the higher prices a trade war brings? The media is filled with debate over whether US consumers or Chinese companies suffer the costs of the tariff war, with cheerleaders available for either side. As always, the truth is somewhere between the two. Last year it seemed relatively few Chinese exporters cut their prices to maintain competitiveness, but equally US importers’ prices were little changed as well.
How could this be? Partly this is because US companies were unusually well placed to absorb the increased costs, having just seen their tax bills fall dramatically. A year after the tax cuts, any increase in costs will be more obviously reflected in the rate of earnings growth. The difference is largely aesthetic but could discourage importers from absorbing costs to the same extent.
The main burden, however, was largely shouldered by the decline in the Chinese yuan. So US consumers paid largely unchanged prices in dollars, and Chinese companies earned largely unchanged profits revenues in yuan – but the yuan is worth fewer dollars. To that extent at least, Chinese companies have borne the costs of the tariff, even if they may have been relatively painless.
The happy coincidence of US tax reform and Chinese currency depreciation is unlikely to recur, leading to some speculation that the increased tariffs will be more impactful. That is possible but despite the huge numbers involved, the $540bn of Chinese imports into the US last year form just 3.5% of personal consumption expenditure. A 25% tariff is therefore less than 1% of consumer expenditure, and with some tariffs already in place, the burden is smaller still.
Another factor reducing the consumer impact is that some Chinese imports are components in US exports. The consequences for US companies that have Chinese goods integrated into their supply chains are the hardest impacts to estimate, and that uncertainty is a key reason why the stock market reacts negatively to heightening tensions.
Over the weekend the president attempted to play down the impact of the tariff hike, saying, “We are right where we want to be with China”. But Mr Trump has trumpeted the US stock market as a barometer for the success of his presidency. He must know that the economic consequences of a trade war – slowing growth and rising prices – and a corresponding slump in stocks could cost him the 2020 election. There is an incentive for the president to get a deal done, but even so he doesn’t want to be seen to be making it too easy for China.
Since the costs to China of an escalation will be much greater, Mr Trump may be betting that Beijing will back down. Indeed, China has already had a taste of what might be in store if the trade negotiations fail. The initial tariffs imposed on Chinese imports last year triggered a brief slowdown in the Chinese economy, and heightened fears of a global economic downturn.
Historically, the best time to be positive on China is when its government is stimulating the economy to provoke a recovery rather than waiting for problems to be reflected in economic statistics. They seem to be adopting this strategy once again, with policy stimuli – tax cuts and expansive monetary policy – just beginning to bear fruit. First quarter GDP growth, retail sales and industrial production have all been stronger than anticipated, indicating an economy rebounding from the weakness experienced at the end of last year.
But there is the difficult question of which direction policy takes now as the Chinese authorities continue to try and balance stabilising growth with deleveraging the economy. Chinese growth this year looks likely to be closer to 6% than the government’s target of 6.5%, its lowest in a decade. The Chinese leadership have enough to keep them busy already, without the imposition of further US tariffs.
In short, a new trade deal remains in the interests of both parties, and both sides have expressed a desire to keep the lines of negotiation open. Larry Kudlow, Mr Trump’s top economic adviser, has said there is a “strong possibility” the US president will meet Chinese president Xi Jinping to rescue a deal at the G20 summit in Japan next month. Before then, Mr Kudlow said Chinese officials had invited Robert Lighthizer, the US trade representative, and Steven Mnuchin, the US Treasury secretary, to Beijing for further talks. While risks have risen, on balance we still expect an agreement to be reached.
Not that this will necessarily end sniping between the world’s two economic superpowers, as behind the past year’s tit-for-tat trade war is a larger battle that we expect to play out over the next decade.
For much of the past century, the US’s technological dominance has put it out in front of the rest of the world in many areas critical to the US economy. But the Chinese authorities have made no secret of their desire to usurp the US’s status as the world’s technological leader.
The Made in China 2025 strategy sets out the blueprint for China’s bid for technological supremacy. That is a deep worry in Washington. US trade representative, Robert Lighthizer, summed up the view of many in February when he said that “technology is really what separates us from the rest of the world”. He added: “If we end up losing that technological edge, where we are number two in technology, then the world is going to look very different for our children”.
Even if or when a deal is reached resolving the tariff dispute, this sets the stage for a protracted period of declining economic cooperation between the US and China.
In the opening months of 2019, global stock markets have been much stronger than many expected, with US stocks powering to new highs at the same time as volatility has fallen. Much of the outsized market gains since the beginning of the year can be explained by the recapture of lost ground following the dismal closing quarter of 2018, confidence based in part on the better narrative around the US-China trade story and hopes that we were moving towards a resolution of that issue.
There will be no real winners if an all-out trade war between the world’s competing superpowers is sparked, whether by the tariff dispute or an ongoing battle for technological dominance. The US and China have most to lose in this scenario but other countries, including the UK, will be hit indirectly as global economic growth slows in response to a more protectionist environment.
As we said above, we expect a US-China trade deal to be agreed, though it is isn’t clear how quickly that will happen. The whole global economy will gain from any deal that removes the threat of more tariffs and protectionism and further liberalises Chinese markets.
But until a deal is completed, stock market volatility could return at any moment, given the heightened sensitivity around the trade narrative and the seemingly hardball tactics Trump is pursuing.
Nor is this the only area of concern that could make investors jittery. A possible future oil price spike is something that is also being talked about. Once again, the Trump administration is driving events as it looks to take Iranian oil supply off the market completely. In Venezuela and Libya there could be further supply disruptions that send the oil price higher. Over time, higher oil prices can stifle growth as they leave consumers and businesses with less money to spend and invest.
But even in the face of these geopolitical concerns, we don’t believe this is the time to get defensive in portfolios. There are several indicators that we are near the end, but not quite at the end, of the cycle. So far, oil prices haven’t spiked to the point where they are likely to hit consumer spending hard. Without going into technical details, the bond market is also indicating that it would be unusual for a recession to occur in the next 18 months.
There are some parallels here with 1998, a year which was late in the business cycle, when there were plenty of worries emanating from the East, but where the best gains were still to be made.
History tells us that if you go bearish too early – and the cycle at this point can still go on for some time – you can miss out on a lot of prospective returns. We expect volatility to remain high, but until signs of the cycle ending emerge, we expect to be rewarded for remaining invested.
Guy Foster, Head of Research
Guy leads Brewin Dolphin’s Research team ensuring that a rigorous and exhaustive investment process is employed. He also provides recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. Before joining Brewin Dolphin in 2006, Guy was an Investment Director at Hill Martin (Asset Management). Guy has a Masters in Finance from London Business School. He is also a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.
1 BBC: US accuses China of backtracking on trade deal, 7 May 2019.
2 BBC: China accused of trade ‘rape’ by Donald Trump, 2 May 2016.
3 Fortune: Trump Warns China He’s ‘Tariff Man’ if Trade Negotiations Falter, 4 December 2018.
4 Financial Times: Trump-Xi trade talks likely at G20 summit, US says, 13 May 2019.
5 South China Morning Post: To protect US trade, Donald Trump needs to stand firm on intellectual property protection demands with China, 7 May 2019.