Stocks dipped into correction territory again due to fears of trade war with China.
President Trump announced tariffs on $3 billion US imports including aluminum and steel. He announced possible tariffs on $60 billion goods. These could go into effect on 1,300 products by April 6.
What does this mean for investors?
We all know that trade wars (like all wars) are not good. Trade wars can escalate, causing serious disruption in global trade. If you studied economics in high school or college, you know that specialization is good. You may also know about “comparative advantage.” Comparative advantage is when one country is relatively better at making something. In other words, even if one country is better at everything, trade is still beneficial. Everyone benefits from free trade.
You probably know that much of the problem with the US trade deficit is due to globalization. Consumers want the cheapest goods. And manufacturers want to provide them to consumers. This means they will find the cheapest source of labor, wherever it is. This caused a lot of jobs to move to Mexico and then to China. Recently it has caused jobs to move from China to other countries in Southeast Asia. Eventually it will cause a lot of jobs to move to Africa.
The trade deficit with China is about $375 billion. Trump has demanded China slash this to $100 billion. It's difficult to see how this can happen.
That said, China’s trade policy with the US appears one sided. For example, China charges 25% tariff on US cars. US charges 2.5% on Chinese. Trump has asked to make this “reciprocal.”
President Trump has also asked China to buy semiconductors from the US. If China does, it will buy less from South Korea and Japan. You can see how this has the potential to hurt the global economy.
But some other things are relics of a communist past. China, for instance, won’t allow US firms to own over half of a company in China. This means the US companies must have “joint ventures” with existing Chinese firms. Joint ventures can be a great way to gain access to a country. But no company likes being forced to enter one. Especially if it is a state-owned company.
Because China continues to subsidize state owned enterprise, they have lower costs. This gives these companies an unfair advantage over competitors. Worse, the state-owned enterprises don’t correctly respond to market forces and stagnate. Believe me, I know what this looks like, having seen it first hand in Ukraine.
Free trade is better for everyone. But it must be truly free. Currently it is not.
Another problem is the regulatory environment. The US Chamber of Congress says regulations make it hard for US companies to do business in China. It cites opaqueness, unpredictability, and basic problems of market access as key impediments.
What this means for investors depends on how you view the President's motives. If, on the one hand, he seeks to gain favor for American workers, to level the playing field, it's good. It's good because it will put us on the same footing as others. If on the other hand, he has some other nefarious motive then it may not be good. But frankly it is difficult to divine exactly what they might be.
While it is impossible to know, we do know he campaigned on this issue. Because he has announced he will seek a second term, he wants to honor that promise.
Taking on China has garnered support from the Senate Minority Leader Chuck Schumer:
Because we have access to the professional research done by Morningstar stock analysts, we can share their view. They consider the impact of tariffs thus far to have minimal impact. Specifically, the impact isn’t enough to adjust the fair value of Boeing, GM, Ford, can manufacturers or any other major companies affected by current tariffs. Should further threatened tariffs be levied, like those China has suggested will take place May 22, this could of course change.
In the short run this is likely to cause continued volatility. But in the long run these efforts may allow US companies better access to foreign markets. As we highlighted in an earlier blog Weather Market Corrections, corrections happen about once a year average -13.3% down and last about 14 weeks. If this one started January 26 on average it would be over sometime in May (on average and as expected).
While this doesn’t mean the correction WILL be over by then (and could turn into something worse), it means so far this appears to be a normal correction.
This creates opportunity for enterprising investors. Professional portfolio managers know the relative risks. Which means when retail investors overreact ... it creates buying opportunity.
It’s literally how professional active managers get better results.
Remember, we have taken it upon ourselves to be the advocate for our clients. This means we always strive to be above politics and short-termism. Instead take actions to help our clients in the long-run based on their specific goals, risk tolerance and fundamentals.
For this reason, parents, and grandparents should have another concern. They should make sure decisions they make today help their kids prosper in the new economy. Two ways our clients are doing this include:
- Investing in the debt of "middle market" private companies. This has been highly profitable, AND it helps them to grow. It’s why we use the interval funds and are pressuring Morningstar to provide better performance benchmarking.
- Investing in the equity of smaller companies. Its why we are always on the hunt for better funds. When they become to big they become riskier and lose return potential.
These companies are the disruptors and innovators making the future. They are our children's future employers.
Parents and grandparents can also strive to educate their children and grandchildren. Every young adult needs to learn how value to create value to others. Innovation rewards the few. Handsomely – some say winner take all. It is important that our youth discover what they love to do and figure out how to get others to pay for it.
I advise clients to read the following books on this. And to encourage their children and grandchildren to do so:
- Sapiens: A Brief History of Humanity, Yuval Harari. This book covers the history of the human species. It shows how capitalism (taking a risk to bet on the future) has been the driving force behind our prosperity.
- The Rational Optimist, Matt Ridley. This book describes how human progress has occurred and why economics must drive our decision making. Because if it doesn’t make sense economically, progress can never happen.
- Influence, The Psychology of Persuasion, Robert Cialdini. This classic, written in 1984, describe the key principles governing how people make decisions. Specifically, it describes how people are persuaded to make decisions. Either you understand this (and are persuading others) or you do not (and are persuaded by others).
The reason I recommend these books is threefold. First, the economy grows because people are willing to make a bet today on a future return. Capitalism, as flawed as it may be, is the only mechanism to achieve that. Second, we cannot make predictions on the future based on current technology. Just like interest compounds, so does learning. As long as we continue to invest the future is likely to look much better than the present.
Finally, every young person needs to understand the science of persuasion. Understanding how influence works, and using it in their favor, creates an advantage. Whether you use it to understand when you are being influenced or to wield influence, it works.
This skill will always be in demand.
