As we had laid out in the 1st Quarter edition of this publication, markets have generally been in a sideways-type of consolidation pattern for most of the year to this point (see chart below). As can be seen in the chart, after peaking out at almost 2900 at the end of January, the S&P 500 has indeed traded range-bound for the balance of the year.
Despite all the talk and threats of tariffs and the very negative toll they would impose, markets have held up surprising well. Insofar as markets tend to be discounting mechanisms of future events, the fact that there has not been a meltdown in the face of all the tough talk around a trade war really does suggest that the US economy and by extension the global economy will ultimately find a way to work around these debilitating costs.
That said, given the magnitude of the impact to the US economy, the Global economy, and the associated investment markets in the event of a full out trade war, we felt it important and useful to speculate how such a trade war might develop and what the likely impacts would be.
Our feeling is that, with the exception of China, much of the trade actions thus far with Canada, Mexico, and the European Union are primarily aimed at positioning the Trump administration as a protectionist administration in advance of the bigger goal that is China. Tariffs placed on the import of steel and aluminum put in place recently with Mexico, Canada, and the EU will be felt by both sides, but in the grand scope of overall trade, these tariffs are in fact relatively minor. Obviously for US based producers who need steel and aluminum, these tariffs have raised their production costs. At this point, we have not yet seen evidence that these producers have been able to pass these higher costs onto their customers, but that would be a first-order concern from these tariffs.
The bigger effect thus far from these tariffs has been the reciprocal tariffs put in place on the export of US goods to Canada, Mexico, and the EU, which have largely been upon agricultural goods. Although the administration has offered so far $12 billion in farm subsidies to help offset these lost exports from American farmers, its hard to imagine that will be nearly enough as the US typically exports more that $16 billion of agricultural goods to Canada alone.
Still, within the grand scope of a $20 trillion US economy, these tariffs shouldn’t be nearly enough to overturn the impressive US economy we are enjoying today.
We believe that the strategy here by the Trump Administration is more aimed toward not only forcing China to import more US goods, but to also discourage the US export of intellectual property, such as patents and other technology in exchange for access to China’s consumers. So far, China has not shown much interest in cooperating with these requests. We do believe, however, that China will have to concede, at least partially, for the following reason. Most of what China does import from the US are either intermediate goods (semiconductors in particular) that are used in the manufacture of Chinese exports or are somewhat monopolistic goods, such as airplanes. Being a highly export dependent economy, China will need to concede in some other areas in order to secure these intermediate goods less they find other suppliers. Obviously, the US would carry more leverage in this regard had the Trump administration better coordinated these efforts with other countries capable of supplying these intermediate goods, but that would have likely necessitated remaining a party to the TPP (Trans Pacific Partnership).
Consequently, we are hopeful that the US and China will come together on a bilateral trade agreement that will allow each side to claim a victory publicly. At least, that what the markets seem to be anticipating at this point. Should this view begin to erode, we are keenly aware of the companies in your investment portfolio that are either dependent on China for their revenue or as a supplier, or both, and would obviously move to trim back those holdings should the current trade “skirmish” go more hot.
As always, please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us. This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).
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Mark P. Culver
Culver Investment Company, LLC
360 Interlocken Blvd
Broomfield, CO 80021
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