Should investors prepare for a trade war?

Russell Price, Senior Economist, Ameriprise Financial

Potential trade tariffs and trade war

May 2018

Key Points

  • Markets are jittery over the potential trade war between the world’s two largest economies
  • The trade issue for the U.S. is not just about free trade, but fair trade
  • Investors can help buffer portfolios from related volatility with a well-balanced and diversified approach

Trade issues have been a hot topic this year. In recent months, tariffs were imposed on aluminum and steel imports, and the Trump Administration has proposed tariffs on billions of imports from China. 

The economic threat inherent in rising trade barriers has been a key source of financial market turbulence this year. Investors are rightly concerned that added tariffs could raise consumer prices and reduce export opportunities for U.S. companies.

In our opinion, the threat to economic activity is limited based on the specific actions announced thus far. However, further escalation is a legitimate risk that could carry more serious consequences.  

The skewed balance in trade

China is the primary target of the Trump administration’s tough-talk on trade. In 2017, the U.S. imported goods worth $506 billion from China, while exporting $130 billion, according to the Commerce Department. The resulting trade deficit with China of over $375 billion represented two-thirds of the total U.S. trade deficit for the year.    

It’s not just about the trade deficit

Trade deficits by themselves are not necessarily a bad thing. However, the debate is more complex than the headlines may suggest.

Administration officials have said they want to see a smaller deficit, but the primary goal is to get China to offer a fair playing field for U.S. businesses.

China employs practices that many countries decry, such as requiring some companies that do business there to transfer their technology to a local business partner. Other concerns include weak intellectual property enforcement (including accusations of trade secret theft via cyber espionage), barriers to imports, and excessive government support for certain key industries.

These policies are widely seen as part of China’s “Made in China 2025” initiative. In 2015, China’s central government announced its goal of dominating 10 futuristic, high-value industries by the year 2025. A partial list of the sectors and sub-industries targeted includes aerospace, semiconductors, robotics, solar power, artificial intelligence, and cloud computing. These industries are currently the “bread-and-butter” for many western economies, most notably the U.S.

Escalation is the real threat

An escalation of the current trade dispute may be the greatest fundamental threat to the near-term economic outlook. Fortunately, a potential deterrent to further escalation is that neither side would benefit from this path.

Conversely, bilateral negotiation to improve trade policies on both sides could improve the economic prospects of all involved. As such, despite the tough talk presented on both sides as of this writing, we believe a sensible negotiated agreement could still be the most likely outcome.

Tough talk, not yet turned into action

It’s also important to note that most of the announced tariffs are proposed, not yet implemented. When the Trump administration announced its intended tariffs on Chinese goods in early April, it said no action would be taken until after a 30-day comment period, which ended in early May. The administration has given itself a window of 180 days, which started after the comment period, to make any final decisions.

One consideration the Trump trade policy will likely take into account is the importance of trade to the U.S. economy.

In 2017, trade represented nearly 1/3 of total U.S. economic activity, with imports accounting for 16.3% of economic activity and exports amounting to 12.8%.
 — Commerce Department Data

Considerations for investors

When stock prices are steadily rising as was the case last year, it’s easy for investors to shift more of their assets into equities as a means of trying to capture some of that momentum. This year’s financial market activity, and the risk posed by the threat of a trade war, is a clear reminder of the importance of a balanced and well-diversified portfolio.

A good course of action over the long term is to talk with your financial advisor about your investments and how to align them with your unique goals, risk tolerance and investment time horizon. Your advisor can help ensure your portfolio is properly diversified given your goals and the uncertainties that exist in today’s market.  

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