Stock markets haven’t priced in a Never Ending Trade War

Investors consider tariffs and the trade war as only being temporary. A U.S. – China trade deal, will sound the all clear signal for markets and the economy. But there are indications that we may be in for a longer, more prolonged set of trade battles. A Trade War could last as long as Trump remains in office.

Consider:

  1. U.S. steel and aluminium tariffs remain in place even after the U.S. signed a new trade deal with Mexico and Canada on Sept. 30.
  2. The administration wants to retain the ability to slap punitive tariffs on China permanently as part of a new trade deal.
  3. The administration is moving to institute $11 billion in tariffs on European aviation imports, and there are concerns that the next step is tariffs on European auto imports.

 

Bank of America Merrill Lynch global economist Ethan Harris has said he expects trade wars to continue over different issues and with different trade partners, even if there is an agreement with China. “The trade war is not going to go away during President Trump’s tenure in office. I think it will go through periods of hot war and cold war,” he said.

 

There are political and economic reasons for a long trade war.

On the political front, Trump campaigned on reviving U.S. manufacturing, reducing trade deficits and making better trade deals.  A continued pitched battle with U.S. trading partners shows his political base that he is fighting for them in hopes of being re-elected. Also, the trade hawks in the Trump administration want some form of permanent tariffs in place and welcome trade battles.

On the economic front, the Trump administration believes that tariffs are a good negotiating tool to force countries to eliminate unfair trade practices. The goal is giving U.S. industries protection to redevelop and gain market share back from China and other low-cost competitors.

Unfortunately, temporary tariffs won’t work. It’s clear that a manufacturing revival requires substantial investment and it takes a lot of time to move plants back to the United States.  Capital will only flow to these industries if it believes its protections from cheap foreign goods is permanent, not temporary.

How tariffs are hurting the economy!

  • Trade uncertainty has damped corporate spending on capital projects.
  • Corporate profit margins are expected to contract because tariffs have increased costs but market conditions won’t allow corporations to increase prices.
  • Share buybacks are at all time highs, a sign of low business confidence.

Year to date, the North American stock markets have been steadily rising. However, first quarter earnings estimates have been reduced and disappointing results could spark a market correction. Fund managers have been getting defensive as one of best performing sectors during the past 12 months has been utilities.

Timing the market is next to impossible but investors are still buying on rumors of a U.S. – China trade deal and probably sell on news. You may want to avoid putting any new money into the markets or raise some cash and wait for a better buying opportunity.

 

 

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Why Trump’s zero tariffs & zero subsides is a pipe dream

Trump campaigned on getting better trading deals starting with the renegotiation of NAFTA.  The loss of U.S. manufacturing jobs is the main reason that the Trump administration has criticized NAFTA and other trade deals. According to the CFR, the U.S. auto sector lost roughly 350,000 jobs between 1994 and 2016. Many of those jobs were taken up by workers in Mexico, where the auto sector added over 400,000 jobs in the same period.

A few reasons why zero tariffs alone don’t work

  • Labour intensive manufacturing will tend to locate where employee wages and benefits are the lowest.
  • Local and federal tax rates are another factor when it comes to plant locations.
  • Input costs like regulations, transportation and power rates are just a few examples of factors in plant location considerations.
  • It makes economic sense to locate near the biggest market for the product or service.

Bottom line, can the Trump administration force China and Mexico to pay $25.00 a hour to assemble cars? Are American consumers willing to pay an extra $1,400 to $7,000 for a new car if Trump imposes 25% tariff on the auto sector? How about $3,000 for a new I-phone that is made in America?

For argument sake, I do believe that reducing tariffs among developed countries does make sense. However, the other problem is fluctuations  in currencies which governments in general have little or no control over. For example, only yesterday, President Trump doubled the tariffs on Turkish steel and aluminum because of the drastic fall in value of the Turkish lira.

The hard fact is zero tariffs are not feasible and corporations are not patriotic. Corporate executives are more concern about keeping their shareholders happy and ensuring a very generous executive compensation package. Wage growth in the U.S. has been stagnant for many years and there are no signs that the corporate tax cuts have trickled down to employee wages.

Is eliminating government subsides even possible?

My short answer is no. The great recession of 2008-09 would have turned into another great depression if governments’ world-wide didn’t bail out their troubled banks. How many jobs would have been lost in the auto sector if the U.S. government didn’t bail out Chrysler and GM? (Does too big to fail, sound familiar)

Severe weather conditions make it difficult for governments to get rid of agricultural subsidies. Plus, governments can use subsidies to ensure that farmers produce the right amount of crops or meat to serve their population. There is also a safety issue and a cost benefit to using your own food sources rather than relying on importing food from other countries.

I could go on and on with other examples of industries that require some form of government help. Not all subsides are bad. Think about the millions of people who use public transportation. How expensive would it be, if it wasn’t subsidized by government?

All comments are welcome!