The trade dispute between the USA and the rest of the world is driving headlines, and markets. While China is the primary focus, the White House has picked fights with Mexico, Canada and Europe, among others. Given the often confounding and wide-ranging scope of the rolling trade brawl there’s a danger that investors are placing too much emphasis on its potential impact.
One issue is that investors tend to see the dispute through an economic lens. This led many to expect a quick negotiation. After all, it’s in every countries' interest to have stronger trade relationships, so the US and China should find a fast track to trade peace. The problem is that the major players see the issues through a political lens.
Presidents Trump and Xi are acutely attuned to their respective domestic audiences. Much of the public trade discussion is for broad consumption, not the comfort of investors.
This could mean trade differences between the US and China rattles on for months, or even years. Many analysts are focussed on the G-20 leaders’ summit in this week as a stage for a potential resolution. However, the next US presidential election is in November 2020. It’s conceivable that the White House could see political advantages in keeping the disagreement alive until then.
If the current misalignment continues, does it matter? What is the effect if every threatened tariff is introduced? Estimates vary, but most centre around a hit of 1.2% to China GDP (currently 6.0% to 6.5%) and a reduction of 0.6% in US GDP (3.0% to 3.2%). Clearly tariffs alone will not bring the end of the financial world.
The trade dispute is not an existential threat, but there are other, more remote risks. Conflict and slowdowns can hit consumer and business confidence, weighing on sentiment and markets. At the extreme, the drag on global growth from tariffs could spark a downward spiral in economic activity and confidence, leading to a market meltdown.
This extreme scenario is unlikely simply because it is well explored. Investor worries mean that portfolio cash levels are higher, leverage is lower and tilts are defensive. These are not the ingredients for a market crash. Bear markets are born in optimism and exuberance, not gloom and scepticism. The stated willingness of central banks everywhere to leap into action if economies crumble adds a safety net.
A more likely path is that there will be constant, partial solutions. Both Beijing and Washington will see in the other a convenient paper tiger. “Two steps forward, one back” would suit the economic and political interests of both leadership teams, as they demonstrate their political strength against others and the ability to deliver good economic outcomes.
Asia Pacific investors could ignore the noise. Already markets are showing signs of headline and tweet fatigue, with more moderate reactions to developments. There’s also an argument that regional companies could benefit from a prolonged trade argument. As supply chains are ruptured by tariff barriers there could be opportunities for “neutral” businesses to step up. Many APAC nations have a stronger trading relationship with China and the US.
Trade concerns may be here to stay. The laws of diminishing returns could apply to related news as markets become accustomed to a constant renegotiation of international relations.
What does matter to investors? Market focus will likely return to the usual suspects - growth, inflation and employment. Anticipated growth rates could drive stock valuations, and employment may inform central bank activity. The interplay between stronger economics and tighter money, or weaker data and easy money, is the key to market reactions.
This means inflation is potentially the greatest worry over the next twelve months. If inflation moves higher from current historic lows it will limit the ability of central banks to respond. Interest rates are very unlikely to fall if prices accelerate upwards. Rising inflation has the potential to break the nexus between growth and monetary conditions. Volatility in markets could explode as the globe adjusts to a new investment paradigm.