This is part of an ongoing series of articles published by Johnson Financial Group. This issue is written by Brian Andrew, EVP, Chief Investment Officer.
Last week, I was helping my son study for his fifth grade history exam. His class has been learning about the development of societies as they study ancient Mesopotamia. He told me about Shamshi‐Adad who ruled Assyria from 1813 to 1781 B.C. He understood the importance of trade and how it could benefit the place he ruled. As we reviewed the exam information, it was interesting to see how the city states of that time learned to use trade to their advantage. Of course, with trade in the spotlight for investors, I couldn't help but draw comparisons to our own time.
In a tweet last night, President Trump noted “the U.S. has made substantial progress” and so he “will be delaying” the increase in tariffs (from 10% to 25% in many cases) scheduled for March 1st. He indicated that progress has been made in the areas of “intellectual property protection, technology transfer, agriculture, services, currency…” Improvements in trade talks have partially fueled the stock market rally we've experienced since the beginning of the year, so the current state of affairs bears watching.
China accounts for half of the U.S. trade deficit even though the volume of trade nearly matches that of Mexico and Canada. In addition, after years of U.S. companies losing intellectual property and technology to the Chinese, some have cried “Enough.” As a result, one of the Administration's policy pillars was to improve trade relations with China, address the size of the deficit and the issues surrounding safeguarding technologies.
This is a difficult prospect because U.S. policy makers play a short‐term game, from election to election cycle. On the other hand, the Chinese are allowed to play the long game, benefitting from the uniform power of the communist party.
Still, the tariffs put in place last year, in addition to the transformation of the Chinese economy toward domestic consumption, have put pressure on Chinese economic growth. As you can see from the chart below, the Chinese economy's growth rate has slowed significantly since 2010. And, the official statistics show the economy growing at a rate that is 6% slower than one year ago. Unofficial statistics indicate a more dramatic slowdown. Inflation too has declined.
In January, the IMF updated their 2019 forecast and indicated that global economic growth would be slower than anticipated months earlier and lowered their forecast by almost 6%. They specifically cited “global risks tilt to the downside” indicating that “an escalation in trade tensions (between the U.S. and China) remains a key source of risk to the outlook.”
While we wait for news of a trade deal, we would expect that the stock market will appreciate on any news from the Administration and Xinhua (Chinese news agency) that suggests progress. More than likely, the deal itself—if anything like the USMCA (the Mexico/Canada deal which has yet to be ratified by Congress)—will fall short of the most optimistic expectations. However, if it leads to the resumption of purchases of agricultural products and a reduction in tariffs between the two countries, it will be seen as progress. The big question will be whether or not there is meaningful change with respect to intellectual property protections and technology transfer.
At this point, the extension of the trade deadline beyond March 1st suggests that the bar for a deal is lower than it was a year ago when tough tariff talk was all there was.
The Administration's chief negotiator, Robert Lighthizer, is a trade hawk as far as China is concerned. This Wednesday, he will report to Congress, and it is possible that his rhetoric will sound more negative than what we've seen in the popular press both in the U.S. and in China. As a result, we should prepare for some asset price volatility. Of course, Mr. Lighthizer isn't a politician and doesn't have to worry about his constituents or approval ratings—President Trump does. This was apparent at a news conference yesterday when the President and Mr. Lighthizer disagreed over the meaning of Memos of Understanding (MOU's). These memos represent “contracts” according to Mr. Lighthizer whereas Trump considers these as outline aspects of a deal.
We may also learn more about the specifics of a summit between President Trump and President Xi Jinping in late March. If it looks like a summit will take place, then the expectation from markets may be that the tariff situation is stabilizing. If the prospect of a summit is dim, then it is possible that higher tariffs will occur—this is certainly not priced into stocks of affected companies, and volatility would resume.
While Mesopotamian rulers had force as their friend when it came to trade, we suspect current societies will forgo this avenue and focus more on making a deal. Nonetheless, asset prices will move with the winds of change as we learn more about the possibility of a trade deal with China over the next month.
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