FICS Editors' Note

On Monday, 05/13/19, China responded to the latest round of U.S. tariffs on $200 billion worth of Chinese goods by saying it would raise its own tariffs by as much as 25% on a list of U.S. goods worth $60 billion.

No one is blinking on trade. Here's what it means for investors

  • By Reshma Kapadia,
  • Barron's
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The reality is sinking in. A trade deal between the U.S. and China may not come soon, and that would mean more market volatility and possible consequences for U.S. companies.

The Trump administration just raised tariffs on China, the president tweeted that there was no rush for a trade deal, and negotiations on Friday ended without one. The Chinese have made it clear they would respond if tariffs rose.

“If investors think a deal is just around the corner, they are engaging in wishful thinking,” Scott Kennedy, the director of the Project on Chinese Business and Political Economy for the Center for Strategic International Studies, said in an email.

“The Chinese are far more likely to retaliate in the next couple of days than cave into American demands. Even though an escalation will hurt China’s economy, the Chinese leadership more than likely still prioritizes protecting their industrial policy system over achieving trade peace with the U.S.

“Conversely, a growing trade war has yet to hurt the American economy or President Trump’s political standing. So until the economic pain and political costs become more severe in either place, I don’t see the two sides reaching a settlement.”

Sonal Desai, chief investment officer for Franklin Templeton’s fixed-income group, played down the potential fallout from increased trade friction in a presentation at the Morningstar Investment Conference in Chicago. Though Desai said escalation of trade friction would create a temporary hit, she doesn’t expect tariffs to be permanent. Nor will they throw China off course—in part because China still has room to stimulate its economy to cushion any impact, she said.

Trade tensions may not harm global economic growth as much as some fear. Growth in trade has fallen to an annual average of 2.8% from 2011 through 2018, versus 7% between 1992 and 2006, yet the pace at which the world economy has expanded hasn’t suffered correspondingly, Desai says. Growth in gross domestic product averaged 3.6% a year in the most recent period, compared with 3.7% in the earlier stretch, she says.

It’s the U.S. consumer that is the engine of growth, although China still looms large in terms of demand for commodities, she told Barron’s.

Richard Sneller, manager of the Baillie Gifford Emerging Markets fund (BGEHX), isn’t as fearful about the back and forth between the U.S. and China over the long run given their reliance on each other. “A weak China is a disaster for the U.S.,” he told Barron’s.

That mutual dependence is what is driving fund managers’ and strategists’ expectations that some sort of deal will eventually come to pass. But the uncertainty around the timing means increased volatility and contentiousness, Mona Mahajan, U.S. investment strategist at Allianz Global Investors, told Barron’s via email.

The focus now is on how the Chinese will respond. “Keep in mind, they only import about $100 billion in U.S. goods so other forms of non-tariff barriers like bans on certain brands become more likely,” Mahajan says.

She is also watching how the foreign-exchange market responds. A continued rise in the dollar versus the Chinese yuan would hurt U.S. exporters and help Chinese companies.

China has responded with boycotts against goods from other countries in past periods of strife. In 2017, after South Korea bought an antimissile defense system from the U.S., China boycotted Korean products. Korean auto makers’ car sales in China took a hit, and the number of Chinese tourists visiting South Korea fell by 66% in the second quarter of that year. Even K-pop stars were denied visas.

“With the global economy slowing, one of the brighter spots had been the U.S. consumer, which has shown resilience,” Mahajan says. “The renewed trade war will test this consumer resilience.” Although she expects Chinese economic stimulus to keep asset prices there from falling too far, Mahajan had been selling Chinese equities ahead of the latest tariff increase following a sharp rise in stocks there this year.

She’s putting more money in defensive sectors in the U.S., such as health care and staples.

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