If you’re trying to figure out an investment strategy to deal with the ongoing trade war, here are some thoughts to help inform your thinking:
- No end in sight? An extended global trade war is now the base case for many analysts and investors. Beyond that, with tariffs being used as leverage against Mexico for immigration, they’re no longer just a trade negotiation tool.
- Research shows U.S. consumers are paying for the tariffs, almost entirely, through higher prices. The effect on the economy is a tax increase offsetting last year’s tax cut.
- The promised manufacturing jobs haven’t come back. Instead, manufacturers are switching supply chains from China to Vietnam, Indonesia and other low labor cost areas. U.S. manufacturers are more likely to invest in automation than new hires.
- A Federal Reserve rate cut isn’t an easy answer to keeping the economy growing. U.S. companies have capital for investment; the unpredictability of the trade war is dampening CEO confidence in making the capital expenditures (CapEx) that could provide a boost.
- If CapEx stalls, it would take something like a large infrastructure deal to offset the economic erosion being caused by the tariffs. However, the prospects for such a deal seem dim.
For private equity funds, institutions and other large investors, keeping up with the sudden shifts in how the U.S. is leveraging tariffs for trade and other political purposes is the challenge. Investors rely on a degree of predictability, particularly in evaluating the potential impact of government policies. With the trade war, we’re left to search for clues to formulate a way forward.
This Trade War Is Different!
Rodrigo Adao, assistant professor of economics at the University of Chicago Booth School of Business, notes two studies showing U.S. consumers are paying a disproportionate share of the U.S. tariff costs—a burden typically shared between trading partners.
The first study, “The Impact of the 2018 Trade War on U.S. Prices and Welfare,” by researchers at the Federal Reserve Bank of New York, Princeton University and Columbia University, states: “Overall, using standard economic methods, we find that the full incidence of the tariff falls on domestic consumers, with a reduction in U.S. real income of $1.4 billion per month by the end of 2018.”
The second study, “The Return to Protectionism,” is no more encouraging, particularly for those hopeful of a renaissance in U.S. manufacturing jobs. A team from UCLA, Yale, The National Bureau of Economic Research and the Columbia University Graduate School of Business concluded: “U.S. tariffs favored sectors located in politically competitive counties, but retaliatory tariffs offset the benefits to those counties. We find that tradeable-sector workers in heavily Republican counties were the most negatively affected by the trade war.”
According to Professor Adao, manufacturers could use automation to replace Chinese workers, in lieu of hiring. “We’re paying a cost in terms of U.S. consumer prices in order to get those jobs,” he says. “Are we getting the jobs, or are we getting more automation?”
Searching For Clues
Don Rissmiller, chief research officer at Strategas, says, “The tariff is a tax paid by domestic consumers, and it’s not great for a consumer economy.”
Mr. Rissmiller has identified capital spending as the biggest factor to watch in gauging prospects for the U.S. economy. “Investment correlates closely with CEO confidence, which is a leading indicator for capital spending and investments,” he said. “After the tax cut, there was a big increase in CEO confidence and a pick-up in CapEx spending. It all turned around in the second half of last year when the trade war started.”
And Mr. Rissmiller isn’t confident CapEx spending will increase in the near term. “A responsible business plan would be to wait,” he says. “It makes perfect sense to hold off on investment plans and wait and see.”
In the meantime, the financial community is looking to the G20 meeting at the end of June for indications of a break in the impasse between the U.S. and China, the centerpiece of the global trade war. What might influence a shift in U.S. strategy? “Economic data, especially employment data, is a good indicator,” Mr. Rissmiller says.
What’s An Investor To Do?
In reading what he refers to as an “extremely unpredictable geopolitical environment,” Tony Roth, chief investment officer at Wilmington Trust (the wealth advisory arm of M&T bank), says his group moved to neutral on risky assets immediately after President Trump’s tweet about imposing additional tariffs on China after it reneged on aspects of a trade deal. According to Mr. Roth, unless there is a surprise resolution to the trade standoff, he believes “the economic situation will continue to deteriorate.” He adds that it is premature to go further in shifting strategy relative to risky investments: “You don’t want to be underweight on risky assets unless you’re confident you’re slogging through a recession, and we’re not there yet.”
However, Mr. Roth says there is a “better than 50% likelihood” of a U.S. recession in the next 18-months, and sees several opportunities for private market investors to begin exploring now, including pooling capital for bankruptcy or distressed investing; shifts in global supply chain from China to Vietnam and Indonesia; and, for the bold, doing homework to identify opportunities that coincide with a new push for the green movement in energy, real estate, autos and other sectors across the economy.
As for resolving the U.S.-China trade war anytime soon, Mr. Roth is concerned that China may simply be buying time until the next U.S. election, or that the U.S. may accept a bad economic deal if expediency becomes necessary. Meanwhile, he sees the current negotiations as a “failure of nationalism,” with the U.S. going it alone, having abandoned long-standing alliances and multinational structures that would have created a more united global front in negotiating with China.
In the end, it seems investors are left with two courses of action: 1) continue to monitor key performance indicators in the U.S. economy, including employment data and CapEx expenditures; and 2) begin to identify counter-cyclical and other investments more in line with a recessionary economy.
