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Trade Tensions Dominate Second Quarter

July 6, 2018

 

Donald Trump promised to dramatically accelerate economic growth in America by lowering taxes, cutting regulations, and bringing jobs back from overseas through better trade deals. In his first year, the President focused on the first two areas, where he enjoyed broad support from Republicans in Congress. Markets cheered the higher corporate profits that these policies promised, sending stocks to all-time highs. Now that the President has turned his attention to trade, however, the results have been choppy so far: foreign stock markets fell, while gains in the U.S. were concentrated in shares of small company and technology stocks that are perceived, rightly or wrongly, to be insulated in the event of a trade war.

 

The President brings a couple of core beliefs to his latest fight: (1) that the trade deficit is evidence that other countries take advantage of the U.S.; and (2) that a trade war can be won easily. There is strong evidence that the President has it wrong on both counts and, should he continue to press the fight, the collateral damage to the global economy may be significant. For that reason, investors can ill afford to ignore the trade issue. Economists are in general agreement that trade deficits can be influenced by policy, but are primarily created when a country spends more than it saves. In this country, the key culprit is our large Federal budget deficit, which is particularly troubling given that the budget deficit is expected to grow substantially over the next few years due to the recent tax cuts. If the President’s only way to keep score on trade is whether the trade deficit is shrinking, it’s hard to see how he will ever be able to declare victory and stop fighting.

 

Nevertheless, the President believes he has a winning hand: because we buy more from other countries, his thinking goes, they have more to lose and will capitulate first. We see some problems with that argument. First, a prolonged trade war will hurt everyone. Long before companies can build new U.S. factories and bring jobs back, cars, appliances, food and clothing will all become more expensive. People will be able to afford less and some people will lose their jobs. This will prove unpopular, and we have elections – China doesn’t. China almost certainly thinks it can win this fight. Trump is also battling democratically-elected leaders in Canada, Mexico and Europe, and capitulating to Trump would likely prove very unpopular with their electorates. There’s a reason why we haven’t been in a full-scale trade war since the Great Depression: no American President since Hoover has thought he could win one.

 

Given such a dour assessment, some people wonder whether they should just get out of the market entirely. There are two reasons we believe that such extreme measures are unwise. First, this situation may resolve itself. Trump has backed down before when his policies have proved unpopular and he may do so again. More importantly, Congress has the authority – some would say the responsibility – to exercise its constitutional authority over trade and dramatically limit the steps the President can take unilaterally. The second reason to stay invested is that getting out of the market rarely works out for investors. To pull it off, you have to get the timing right twice: once on the way out, and again on the way back in. It’s so rare that when it happens, you’ll probably hear about it. On the other hand, having a solid long-term plan and sticking with it never makes headlines and almost always pays off.

 

A good financial plan is especially important in times of uncertainty like this. More than usual, investors should consider whether their portfolios are built to withstand the turbulence that might lie ahead. Investments that have done well over the past few years are unlikely to do as well in an entirely different market environment. At the same time, market risks are becoming more concentrated in certain sectors of the market as investors pile into recent winners, like technology stocks Facebook, Amazon, Netflix and Google – the so-called FANG stocks. Over the last three years, this group of stocks has tripled in value, raising their share of the popular S&P 500 index from 4% to nearly 10%. Complicating matters further, this gain has come at the expense of those sectors that typically hold up better in a market downturn, like consumer staples, health care and utilities. Considering all of this, there’s no better time than now to review your asset allocation and financial plan, and to assess whether your investments are still constructed to help you achieve your goals.

 

Click here for additional market commentary and analysis.

 

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