How 'Trade Wars' Can Impact Markets - Forbes

MAR 23, 2018 @ 01:25 PM 1,655 The Little Black Book of Billionaire Secrets
How 'Trade Wars' Can Impact Markets
Kenneth Rapoza , CONTRIBUTOR
Opinions expressed by Forbes Contributors are their own.
History shows us that trade conflicts are rarely good for markets.
Selling its Treasury position to an extreme level would impact the yuan.

Deal or no deal? Some in the market believe that tariff threats are a means to bring China to the negotiating table on trade.


We are supposedly on the brink of a trade war with China. While consensus errs on the side of cooler heads prevailing, and better trade deals being worked out, it may be best to err on the side of caution. That means staying away from stocks that might be impacted from retaliatory measures.

"Most of our investments are not linked to trade, so we are not worried about the earnings impact," says Mike Reynal, chief investment officer for Sophus Capital in Des Moines. "On the other hand, we do worry about sentiment in the stock market."

Trade wars conjurs up bad members of Herbert Hoover.

The global trade wars that followed the harsh tariffs imposed by the Hoover administration in the early 1930s following the stock market crash of 1929, deepened the trough of the Great Depression. Worldwide economic hardship led to political restructuring and eventually to World War II.


History shows us that trade conflicts are rarely good for markets.

In a more recent example, President George W. Bush imposed steel tariffs of between 8% and 30% in March 2002, scheduled to remain in effect until 2005. Canada and Mexico were exempt. Like Trump's recent steel and aluminum tariffs (which amounted to a non-tariff), the European Union threatened  retaliatory measures, and went to the World Trade Organization (WTO).

The WTO ruled against the U.S. two years later and Bush dropped the tariffs. Here's what happened to the dollar index over the period.

Schroders
Dollar down.

Equities also took a hit.

Schroders
Equities struggled before making a recovery. Germany’s stock market took the brunt of the hit in Europe.

See: The Fed Is Now A 'Wet Blanket' For Stocks -- Forbes

The prospect of a trade war-driven slowdown follows a period of rising optimism around the outlook for the world, and the U.S. economy in particular, the Schroders investment team wrote in a blog post on Friday.

The International Monetary Fund upgraded its global growth forecasts for 2018 and 2019 by 0.2 percentage points to 3.9% in January. A trade war would probably force them to revisit those numbers.

Some have noted that China can seek revenge by selling U.S. Treasuries. But in doing so, they would likely cause a spike in yield, lowering the value of the bonds they have now, and thus hurting their own dollar reserves. It is not in China's interest to cut off its nose to spite its face, so to speak. Selling its Treasury position to an extreme level would impact the yuan. China has been reducing its Treasury purchases all year.

"It might be that eventually President Trump dials back on his protectionist measures by providing more exemptions from tariffs, or scales back the range of products and/or tariff levels," says Neil MacKinnon, an economist with VTB Capital in London. "The risk of a global recession would then be averted."

In addition to the threat of a global trade war, equity markets have been faced with a more hawkish Fed and the Special Counsel investigation into Russian collusion with the Trump campaign. The investigation is now switching from a pure Russia-related investigation during the 2016 campaign, and is now going back to 2014 Trump Organization financial records. Anything goes.

On Thursday, markets were susceptible to the fall in Facebook's share price, which turned some funds negative on the market leading tech sector.

The memorandum on China signed yesterday by the President makes it clear that the ultimate decision of applying tariffs is on Trade Representative, Robert Lighthizer. He is a China hawk.

Lighthizer has 15 days to come up with a list of products and goods that the U.S. will impose tariffs on and then there will be a 30-day public comment period before they are implemented. China’s tariff announcement was also framed in terms of non-absolutes.

The bottom line is that there are no tariffs yet, and the threat of them gives China a deadline to come up with a better trade deal for the U.S.