What to Make of These Trade Wars

Written by: Ryan Bouchey

If the last two weeks have taught us anything about the stock market it’s this: it doesn’t matter how good the fundamentals of the market or the economy are, if uncertainties exist we are prone to short term volatility and market losses. It doesn’t make the losses hurt any less, but it is important to identify the cause and whether or not these causes could have a potential long-term impact on the markets. The main culprit to this recent volatility has been the fear of a trade war and the fact that the parameters seem to have expanded. Not only are we putting tariffs on goods between the U.S. and China, but we’ve also seen tariffs or talks of tariffs with the European Union and Canada. The more this expands, the more fearful the market will react. It’s important though to keep a few things in mind.

First let’s not forget about stock market fundamentals. First quarter earnings for S&P 500 companies were 25% higher than they were a year earlier. Second quarter earnings are estimated to be 19% higher on a year over year basis. U.S. companies continue to benefit from a strengthening economy, a stronger consumer driven by tax cuts and higher wages, as well as the changes to the corporate tax rates. And valuations are right in line with historical valuations – forward P/E just above 16x, versus the dotcom bubble’s 24x Forward P/E – as you can see well short of a market created bubble. There’s always the chance for the unexpected but at this point there are few recessionary factors in place that have us fearful of an immediate stop to the current bull market.

Now let’s focus on the trade impact. We have to identify what is going on and how long it may or may not last. It is likely that President Trump is playing to some of his supporters – the communities hit hardest by the rise in global trade which has had the biggest negative effect on the steel belt and U.S. manufacturing. While we sympathize with these communities and that part of the country, it’s a short-sighted strategy to only focus on this segment of the country while putting the overall economy at risk. Take steel for example; putting a tariff on Chinese steel may create additional U.S. steel jobs but look at this stat: the American Institute for International Steel says there are approximately 140,000 employees in the steel manufacturing space in the U.S. who may benefit from these tariffs. On the flip side, there are about 6.5 million Americans employed by steel-consuming companies – these are the jobs that are most at risk as the price of steel goes up they will need to cut costs. Just yesterday it was announced Harley-Davidson is moving a factory to Europe because the tariffs with the E.U. will hurt its business. We’re already seeing a loss of jobs from these tariffs from one of the most iconic “American Made” company out there. But if it can’t compete in this environment it has no other choice but to move jobs.

How will some of the proposed tariff’s impact the U.S.? The International Monetary Fund took a look at this two years ago. They estimated if there were 10% tariffs across the board (similar to what’s on the table now) the economy would be .25% smaller after two years than it otherwise would have been. We don’t want to see any policy that will shrink our economy, however .25% won’t have much of an overall impact. It actually reminds me of the fear and drop in the markets at the start of 2016. If you remember, markets dropped close to 14% and one of the biggest fears was a slowing Chinese economy. The impact of these trade wars with China, much like a slowing Chinese economy, is less than 1% of our entire GDP. It has understandably shaken the market in the short term, but we don’t foresee it having much longer lasting effects.

To say that the U.S. has been “losing” in trade through the years is probably a little bit of an exaggeration. Do we get hit with higher tariffs in some countries? At times yes, but look at how well the U.S. has done over the past 60 plus years in the age of a global economy. What other country has a stronger economy? Where else would you rather live if you needed to build a company from scratch? The U.S. has benefited the MOST by this growing global economy and just because we have trade deficits doesn’t mean we’re being taken advantage of or losing. We hope that the President and his administration can come to some solid agreements with these countries sooner rather than later because it would help both the markets and our economy. We don’t want to overreact to what’s going on because we know things can change quickly in Washington, but we did earlier in the year shift the allocation to more smaller-cap companies which should and have done better in this environment as they are less impacted by global trade.

As for now, we do not see a need to make major changes because we still feel that a well-diversified portfolio can withstand this current environment as opposed to any overreactions. If we think the trade wars are heating up and may have a larger global impact, we will certainly be proactive in terms of updating client portfolios. But as of now, the market is still up for the year and its only June. A lot can happen between now and the end of the year and this type of volatility is normal – we just aren’t as used to it recently.