Dear Clients and Friends,
At 401(k) Engineers, it is very important to us that you are well informed about what’s happening in the markets. Here are a few of the key topics of conversation that we feel deserve the most attention this month. If you have any questions or would like to continue the conversation, let us know, and we appreciate the opportunity.
The Ongoing Trade Dispute With China
Normally, I start with the information on the current market situation. But for those that want to get to the “Bottom Line”, I have started there for you. Beyond that, there is additional information into some history and current actions that have brought us to where we are today.
Bottom line
We expect the trade dispute to get worse before it gets better. We see the unrest in Hong Kong, massive debt levels, and the slowing of the Chinese economy as the primary drivers of getting China to the negotiating table. We see the correlation between a slowing economy and the upcoming U.S. Presidential election as the primary driver of getting the U.S. to the negotiating table. However, we don’t see a meaningful resolution here any time soon… unfortunately.
Slower growth could mean lower corporate profits, which will affect stock markets in the long-run. However, we expect domestic markets to settle down and recover in the short-term once this news cycle subsides. Trade news will be replaced by news the Fed is ready to act or another random tweet that gives the market hope. Does it feel like we’ve all seen this movie before?
We are closely watching implied volatility and other market-related data that could lead to portfolio changes as the week progresses.
Our economic calculation point is a month away, and at this stage there are no new data that indicate an exaggerated increase in the recession probability in 2019.
History
Starting in mid-2017, President Trump embarked on renegotiating most of the major trade agreements which the U.S. is part of. This has led to considerable bouts of market volatility (in separate instances) as news related to leaving the TPP, renegotiating NAFTA, the levying of tariffs steel and aluminum, and major tariff placement on Chinese exports have rippled through. Despite all of these, equity markets have set new all-time high’s based on the underlying strength of the economy and corporate earnings.
The U.S. would like a more equitable trading relationship with China, which includes a smaller trade deficit and protection for intellectual property. The tariffs on effectively all Chinese exports to the U.S. are a result of the two governments’ inability to come to terms on these issues.
Today
On 7/30, the most recent round of trade talks ended without meaningful progress.
On 8/1, President Trump announced a new round of tariff’s on China that effectively mean all Chinese goods exported to the U.S. have a tariff on them.
On 8/4, China responded by halting the purchase of U.S. farms goods by state-run businesses and devaluing the Yuan. By devaluing the Yuan below the 7:1 ratio of Yuan to Dollar, China has effectively turned its currency into a weapon.
The 7:1 ratio had been considered “sacred.” Currency traders across the world relied on that barrier as a minimum fixed-peg that has been used for more than a decade. The result of such a massive shock to currency markets has bled into the equity markets, causing the worst single-day loss of 2019.
Implications
The latest moves by both the U.S. and China are part of the “worst case scenario” that has been discussed over the past year.
From the U.S. view:
- President Trump is now committed. He will likely double-down on the new tariffs (moving from 10% to 25%) and may restrict domestic companies from purchasing goods from China (or specific Chinese companies like Huawei) if a substitute is available anywhere else in the world. This would be a massive escalation that would disrupt U.S. supply chains and apply maximum pressure on the Chinese.
- The Trump administration feels China is on the brink of economic collapse. We believe U.S. officials considered the likelihood that China would react powerfully to the new round of tariff’s, so we expect a very rapid, pre-planned response from President Trump.
- We expect the Fed to act aggressively to offset some of the economic damage. This is an incentive to President Trump because he is unlikely to be re-elected if the economy and markets are faltering going into the election.
From the China view:
- China has a systematic advantage of the U.S. due to the nature of their government. They can subsidize industries, enact lower taxes, provide stimulus, and manage their currency much more quickly than a free market economy can. China believes this will give them the tools to outlast President Trump until the election cycle.
- The goal of the Chinese response is to shake the ground under the Trump administration. However, by doing so it also inflicts pain onto itself by inviting higher food costs, the potential for rapid inflation, currency adjustments by other countries that compete with China, and most importantly provided confirmation to the world that China will manipulate its currency for its own benefit.
- China is clearly on the defensive and is reacting to the Trump administration. The tariffs aren’t going to be lifted until a deal is made with the U.S. So, China has the choice to either live with the current outcomes of the trade conflict, negotiate a deal or survive long enough for President Trump to leave office in 2020 or 2024 and hope the next President has a different perspective.
The views expressed here reflect the views of Brian Peardon. These views may change as market or other conditions change. Actual investments or investment decisions made by Cambridge Investment Research and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Moody's Corporation is the holding company that owns both Moody's Investor Services, which rates fixed income debt securities and Moody's Analytics, which provides software and research for economic analysis and risk management. Securities offered through registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a registered Investment Adviser. 401k Engineers and Cambridge are not affiliated. CA Insurance Lic. #0E44645