Escalating trade tensions have made for a difficult investing environment. This is not news to anyone at this point. But investors’ angst was ratcheted higher last week after the Trump administration played its next card—announcing tariffs on an additional $200 billion in Chinese goods—sooner than many expected. Certainly the stock market expressed displeasure, though the 0.9% drop in the S&P 500 for the week still leaves the index with a respectable 4% total return this year. Here we provide our playbook for trade tensions. For additional insights on the subject, see today’s Weekly Economic Commentary.
WHERE WE ARE
The latest $200 billion salvo directed at China garnered the most headlines last week, but there was more: retaliatory tariffs from India, a profit warning from a European automaker blaming tariffs, President Trump’s call for a 20% tariff on EU auto imports, and threats over the weekend to restrict Chinese investments in U.S. technology and certain technology exports to Beijing.
Late last week, reports that the U.S. was prepared to go back to the negotiating table with China before the next round of tariffs go into effect July 6 offered hope that some near-term progress could be made. We will have to wait and see if the influence of the White House’s moderates on trade (Treasury Secretary Steve Mnuchin and National Economic Council Director Larry Kudlow, who plans to go back to work this week after a health scare) prevents the United States from following through on all of its threats.
We have maintained our positive stock market outlook in part because we expect resolution on trade, including with China, and only minimal economic damage to the U.S. and abroad. Our confidence is driven by the following:
- No one wins a trade war: China and the United States each care about their own respective self-interests. Shutting off trade channels between the countries would do significant economic damage to both and is in neither’s best interest.
- Fiscal stimulus kicking in: The amount of stimulus going into the U.S. economy from tax cuts and deficit spending dwarfs the value of the tariffs announced to date. In addition, the impact of repatriating overseas cash as prescribed by the tax law is just starting to be felt.
- Art of the deal: President Trump has a track record of starting a negotiation from an extreme position and then moving toward compromise. Keep in mind that the amount of time between announced tariffs and implementation—typically 60–90 days—provides time for negotiations and that announced tariffs may not be implemented.
- Stock market vigilantes: President Trump cares about the stock market. Bond vigilantes famously influence policy out of Washington, D.C., by moving interest rates. The same can be said about the stock market. In other words, there is a limit to how far the president may take the trade battle if stocks fall enough. We take the fact that stocks have generally hung in okay despite harsh words out of Washington as a positive sign.
- It’s the economy stupid: The midterm elections are coming up and the Republicans do not want to do anything to damage their reelection chances, particularly in the battle for control of the House, which could be a close race. History tells us the president’s party usually loses about 25 seats in the first midterm election, making economic conditions particularly important for Republicans (which is why China’s retaliatory trade actions have targeted political pressure points such as agriculture).