Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.
Not necessarily. Although we believe the announced tariffs are a negative for the global economy, recent market moves have probably more than baked in the pain they will cause. Moreover, it is impossible to know whether the announced measures will be implemented, be scaled back, or fuel a full-blown trade war. Investors with thoughtfully diversified portfolios, which incorporate sufficient liquidity, should stay the course amid today’s trade tensions.
In March, the Trump administration announced tariffs on imported steel and aluminum from several countries; this month, it proposed additional tariffs on hundreds of items imported from China. Not to be outdone, China responded in recent days with a similarly sized package of tariffs on US goods, including soybeans and aircraft. Morgan Stanley estimated that the tariffs announced (through April 4) on more than $100 billion of goods could lower US GDP growth by 0.1 percentage point (ppt) this year, and boost US CPI by 0.2 ppt next year.
Most mainstream economists believe that tariffs do more harm than good. Trade only occurs if it brings mutual benefit, allowing one country to secure goods or services from another that can produce them at a lower cost, a higher quality, or both. The tariffs announced in recent weeks are likely to modestly shrink global earnings and raise consumer prices. Although less-efficient domestic producers may benefit somewhat in the short term, it’s not a zero-sum game—it’s a global negative.
Repositioning a portfolio might make sense if an investor believed that market prices did not reflect the earnings or currency impacts of recent trade proposals. However, there is little question that the proposed tariffs are more than priced in. For example, if we assume that 25% tariffs are applied by the United States and China to $200 billion in goods, prices of these goods would increase by $50 billion per year, all else equal. But, as speculation about potential China tariffs ramped up over the course of March 22–23, the market capitalization of the MSCI All Country World Index declined by about $1.6 trillion.
It is clear that market participants are adjusting prices to reflect not only existing tariffs but also potential tariffs. In a fairly extreme trade war scenario where all US exports and imports are subject to a 10% tariff, Barclays Capital estimates that S&P 500 companies would see 2018 earnings estimates reduced by 11%, fully offsetting the benefits of the tax reform.* Although we believe tariffs this broad and destructive are unlikely, investors should understand that the situation may get worse before it gets better.
Because some probability of a broader trade war is priced in, for investors who wish to de-risk or add risk, the question must be: What do you know that the market does not? These trade skirmishes appear to be guided more by political ends than by economic motivations, and thus their future progress is very difficult to divine; the complexity of global supply chains and global companies will also bring about unintended consequences.
We believe that rather than trying to game out the progress of these thorny political decisions, most investors may be better served by relying on the diversification they have thoughtfully engineered within their portfolio. And if trade tensions do expand significantly, investors with sufficient portfolio liquidity should be positioned to hunt for bargains.
* They estimate that a more constrained scenario only impacting all US/China trade, with NAFTA and other existing relationships left intact, would only dent earnings by 1.2%.
Sean McLaughlin is Head of Cambridge Associates’ Capital Markets Research
Originally published on April 10, 2018
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