Trade Tensions Back in the Headlines

by: , Portfolio Strategist, New York Life Investment Management; Lauren Goodwin, CFA, Economist and Multi-Asset Portfolio Strategist, New York Life Investment Management; ,

Tariffs increased and trade deal delayed

The US-China trade war has returned to media headlines. The White House, frustrated by mired trade negotiations, increased existing tariffs on $200 billion of goods imported from China from 10% to 25%, and proposed a 25% tariff on roughly $325 billion of additional goods. China subsequently retaliated by increasing tariffs on $60 billion worth of US goods. The S&P 500 was down nearly 5% from its high on the news.1

Our base case remains that a worst-case scenario will be avoided, and that a trade deal will be reached before the incremental tariffs have a strong impact on the economy. However, until a deal is reached, we expect related headlines to contribute to market volatility.

Why does it matter?

The latest increase in tariffs is disruptive to the US and global economies. The additional tariffs likely lead to slower economic growth, disrupted supply chains, currency volatility, and high levels of business uncertainty.

Sources: Multi Asset Solutions (MAS), Bureau of Economic Analysis (BEA), 5/14/19. US GDP estimates from 2018 at $20.5 trillion.

Most of the goods targeted by US Tariffs on Chinese imports have been on intermediate inputs. Intermediate inputs are goods and services used to produce other goods. They include raw materials and semi-finished goods sent from China (i.e. fabric to make a shirt). The increase in tariffs on these goods is likely to be disruptive if they are sustained. Manufacturers who use intermediate goods have already been shifting production, diversifying supply chains, or in some cases shutting down. While a year’s worth of tariff threats has likely made some businesses more resilient, increasing costs could force additional manufacturers to raise prices or go out of business.

The biggest economic threat would come from imposing tariffs on the incremental $325 billion in imports from China that currently don’t face tariffs at all. The goods at risk in this scenario are concentrated in capital equipment and final goods. These goods are ultimately consumed rather than used in production of another good. This means they could have a more direct impact on consumer prices. While we view this circumstance as unlikely, higher inflation over several months could push the Federal Reserve out of its “patient” stance and into another interest rate hike.

Potential paths forward

The precise path to trade resolution is highly uncertain. “Tough on China” is a bipartisan issue in the US, and so the Trump Administration would like to see some movement on structural reforms. On the other hand, China insists that all current tariffs must be removed and is unlikely to change its laws for structural agreements.

We think that cooler heads will ultimately prevail. Neither Xi nor Trump want to hurt their countries’ economies or financial markets. For President Trump, 2020 elections are right around the corner. Historically, voters view the economy as a top issue for elections. Xi’s job of managing China’s economic transition from producer to consumer is made increasingly difficult by a trade war. What’s more, the countries’ massive economies are deeply intertwined in consumption, production, and investment. We believe that Trump and Xi are aware of this risk and will likely settle on some sort of trade deal this year.

In the meantime, the scale and impact of threatened tariffs are likely to impact investor sentiment and could weigh on risk assets and business investment as we await a resolution.

Scenario

Indicators to watch

Market impact

Economic impact

What investors may want to do

Trade deal reached in 2019
  • Trump – Xi phone call
  • Trump – Xi Meeting at G20 Summit (June 28th)
  • Agriculture commodity prices
  • Non-tariff retaliation from China (i.e. currency devaluation, export bans, increased oversight
  • Global equity market advances
  • Dollar weakens
  • S&P 500 valued at above average P/E
  • Trade increases
  • Increased consumption and Business Investment
Risk on

  • Overweight Emerging Market Equities
  • Overweight U.S. Equities
“All out trade war” scenario is sustained for 6+ months
  • Equity markets decline, primarily in emerging markets
  • Dollar strengthens
  • Consumer Prices increase
  • Retail Sales decrease
  • Corporate profit margins compress
  • Business Investment falls
  • Unemployment increases

Risk Off

  • Underweight equities
  • Underweight Emerging Markets
  • Overweight cash
  • Overweight liquid alts

Bottom Line

We believe a trade deal will be reached between the US and China. As we wait, it will be important to monitor the dollar/yuan (top right), corporate credit spreads (top left), and US business (bottom right) and consumer confidence (bottom left). Today, these indicators remain relatively strong. A deterioration in these indicators, however, could lead to trouble for financial markets and the US economy, with or without changes in trade policy.

Sources: Bloomberg, Multi Asset Solutions (MAS), NFIB: Small Business Association, Conference Board, 5/14/19.

1. As of 5/13/2019

Disclosure

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

Definitions

The S&P 500 Index is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Robert Serenbetz

Portfolio Strategist, New York Life Investment Management

Robert Serenbetz is the Portfolio Strategist with New York Life Investment Management’s Multi Asset Solutions (MAS) team. He contributes to investment thought leadership and communication efforts across New York Life Investment Management

Full Bio

Lauren Goodwin, CFA

Economist and Multi-Asset Portfolio Strategist, New York Life Investment Management

Lauren Goodwin, CFA is an economist and multi-asset portfolio strategist with New York Life Investment Management’s Multi Asset Solutions (MAS) team, which has $10B in assets under management. She joined NYLIM in 2018 to focus on global macroeconomic trends

Full Bio

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