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Trade war – what is it good for?

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Summary

How we think the current trade war could play out.

3 min read

The trade war between the US and China has become too big for investors to ignore. But no-one wants to risk harming the world economy and a negotiated solution should prevail.

So far the trade war has not had any meaningful impact on markets. The global economy remains in pretty good shape in our view, led by continued strong growth in the US. Other regions are also continuing to expand albeit at a more moderate pace than last year.

Neither President Trump nor President Jinping will want to do anything to change that – for the sake of their political careers as well as the economy.

China in particular cannot afford for the trade situation to escalate. Firstly, the US is a key source of demand for its exports. And secondly, the success of the government’s ‘Made in China 2025’ plan to transform its economy is dependent on strong growth.

 

Global supply chains cloud impact

The global supply chains that characterise today’s trade landscape make it difficult to estimate any long-term impact of tariffs. Few products are manufactured in one part of the world so it can be difficult to impose tariffs on another country without harming industry at home. For example, President Trump’s proposed tariffs on consumer electronics manufactured in China could negatively hit the US technology sector which provides many of the components.

This all adds up to a compelling case for keeping trade tension from escalating into a full-blown economic crisis.

“Both the US and China will want to save face. Both will want to declare victory. But crucially, we believe both will want to find a way forward.”
Sven Balzer, Head of Investment Strategy

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Market reaction

Investors have been aware of the trade dispute for some time now and have already discounted some of the potential effects. This partly explains the recent lack of traction in many equity markets over recent months despite sound fundamentals.

Coutts Head of Investment Strategy Sven Balzer says, “While the rising tension should be taken very seriously by investors, it’s worth remembering that nobody wants a recession. Both the US and China will want to save face. Both will want to declare victory. But crucially, we believe both will want to find a way forward.

“Hopefully, in the end, pragmatism will be the real winner of the trade war.”

 

Our investment approach

Taking into account this changing landscape, we have been re-positioning our portfolios. Changes include:

  • reducing exposure to emerging market equities in favour of developed markets
  • moving money from Europe to the US where we are continuing to see strong economic growth
  • increasing exposure to higher quality bonds

It’s important to remember that the value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

 

A growing issue

The numbers involved in the trade war between the US and China started off relatively small but they are growing. It began with the US imposing tariffs on $34 billion of Chinese goods, followed by further tariffs worth $16 billion. There are threats of more to come, to the tune of $200 billion, by the end of August.

Europe is in Trump’s sights too, with levies imposed on steel and aluminium from the continent and threats of large tariffs aimed at its automobile industry. Both Europe and China have retaliated and talked of further action.

The extent of the tariffs now means that we could see an impact on monetary policy in the US and elsewhere. Recent statements from the US Federal Reserve show they have started thinking about the potential impact on their policies, and the Chinese authorities have started to weaken the Yuan.

 

What if tariffs escalate?

If things do get worse, higher tariffs on US imports would likely increase US consumer prices, but the stronger dollar may partly mitigate that. Also, the current wage growth in the US will make consumers less sensitive to small price increases.

The OECD said in 2016 that a generalised tariff of 10% globally would reduce worldwide trade by around 6% with the US, China and Europe suffering a drop in GDP of 1 – 2% over several years. However, there are many variable factors and the impact could be higher or lower.

Overall, while there may be trade trouble ahead, investors have started to discount the news and the politicians know what’s at stake. While it’s entirely plausible to expect further announcements on this over the coming months, particularly as the US mid-term elections approach, in the end we believe the key parties will want to make a deal.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

About Coutts Investments

With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.

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