Examining the cause and effect of the new tariffs between the U.S. and China

After months of relative quiet, the trade war between the U.S. and China has erupted again in a big way. The markets are the most immediate casualty, with the Dow plunging over 600 points on Monday alone.1

In all likelihood, you’re probably more focused on things like spring cleaning, your upcoming summer plans, and the end of Game of Thrones. My job in this letter is to briefly explain what’s going on, what matters, what doesn’t, and why you can go back to focusing on those other things

So, here’s what’s going on:
Failed deals lead to new tariffs
You may have noticed that headlines about the trade war had been rather muted in 2019. That’s because negotiators for both nations had been quietly working behind the scenes to come to an agreement on how to address the $375 billion trade deficit the U.S. has with China. The White House expressed optimism that a deal was close – until a sudden hardening of positions prompted both sides to retreat to their corners.

On Friday, May 10, President Trump raised the stakes by placing 25% tariffs on all Chinese imports that had previously been spared. Here’s how the U.S. trade representative put it:
“[The President has]…ordered us to begin the process of raising tariffs on essentially all remaining imports from China, which are valued at approximately $300 billion.”2

Throughout this trade war, it has seemed like both countries are waiting for the other to blink first. Both are still waiting. For on Monday, May 13, China announced it would raise tariffs on $60 billion in U.S. goods, some up to as much as 25%.3

Why all this matters to the markets
You’ve heard, of course, of the principle of cause and effect. If one thing happens, something else is affected. Fail to brush your teeth and you get cavities. Leave meat out of the refrigerator too long and it will spoil. You get the idea.
Investors, analysts, money managers, and traders who participate in the markets on a daily basis make decisions based on cause and effect. How tariffs impact certain companies is a perfect example of this. For instance, imagine a fictional American company called Widgets n’ Stuff, or WNS for short. In order to make its widgets, WNS buys thingamajigs from China. But thanks to tariffs, the price of importing thingamajigs goes up.

Investors know this, and thanks to the principle of cause and effect, predict it will have a negative impact on WNS’s finances. Maybe they’ll have to raise prices on their own widgets to make up the difference. Maybe they’ll have to produce fewer widgets. You get the idea. So, investors sell stock in Widgets n’ Stuff because it no longer looks like an attractive investment.

Like them or not, tariffs act as a double-edged sword that affect companies and consumers on both sides of the Pacific. On the American side, China’s tariffs can make it harder for U.S. companies to sell their goods to Chinese consumers. At the same time, American tariffs can make it harder for U.S. companies to import the goods they need for their own products. Either way, prices go up, corporate finances suffer, and consumers are often the ones left to foot the bill. That’s why the markets care about the trade war.

But here’s why all this doesn’t matter to us – yet
The principle of cause and effect is important, but it’s more important to short-term traders than long-term investors like us. That’s because we don’t actually know what the long-term effects are yet. We can guess, but guessing isn’t really a viable strategy in life, is it?

Think of it this way. Let’s say you come down with a fever. The short-term effect is that you probably don’t feel very good. But the long-term effect isn’t yet known. Perhaps it’s just a symptom of a mild cold that will pass in a few days – and that’s why we don’t immediately start chugging antibiotics the moment we feel sick.

While it’s never fun, the markets have fallen after almost every round of tariffs to date. Each time, the markets absorbed the blow, and then rebounded relatively quickly. Previous trade war battles faded into the background and investors turned their attention to other things. Will that happen again this time? We don’t know. And that’s the point: We don’t know what the long-term effects are. What’s more, with the markets having enjoyed a remarkable bull market in recent years, we can afford to be patient. What we can’t afford is to make important decisions by guessing at the long-term effects of these tariffs.

Hippocrates once wrote that, “To do nothing is sometimes the best remedy.” For that reason, it’s okay for you to go back to planning your summer vacation or betting which character will die next on Game of Thrones. In the meantime, my team and I will continue monitoring all the causes and effects in the markets. If, at some point, we have a better understanding of the long-term effects of this trade war, we’ll make decisions accordingly.

As always, please let us know if you have any questions or concerns. We are always happy to speak to you!

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1 “Dow plunges 700 points after China retaliates with higher tariffs,” CNN Business, May 13, 2019. https://www.cnn.com/2019/05/13/investing/dow-stocks-today/index.html
2 “Trump Renews Trade War as China Talks End Without a Deal,” The NY Times, May 10, 2019. https://www.nytimes.com/2019/05/10/us/politics/trump-china-trade.html?module=inline
3 “After China Hits Back With Tariffs, Trump Says He’ll Meet With Xi,” The Wall Street Journal, May 13, 2019. https://www.wsj.com/articles/china-to-raise-tariffs-on-certain-u-s-imports-11557750380

Weekly Market Commentary – September 4, 2018

Where is our country’s biggest export market?
Markets were fired up last week after the United States and Mexico agreed on new trade rules. The Standard & Poor’s 500 (S&P 500) Index reached an all-time high and finished the month of August up about 3 percent, reported Michael Sheetz, Thomas Franck, and Alexandra Gibbs of CNBC.
During the latter half of last week, though, the S&P 500 gave back some gains. A hitch in the giddy-up of trade talks between the United States and Canada caused the index to stumble. Damian Paletta, Jeff Stein, and Heather Long of The Washington Post explained: “High-stakes trade negotiations between the White House and Canadian leaders unraveled Friday, a major setback in President Trump’s effort to redraw the North American Free Trade Agreement…the United States and Canada have interwoven economies, with integrated supply chains and vast amounts of trade. The value of goods and services sold between the two countries last year reached $673.1 billion, making Canada the United States’ largest export market for goods.”

The United States exported about $341 billion of goods and services to Canada in 2017, according to The Office of the U.S. Trade Representative website. Our top exports to Canada during 2017 included:

  • Services ($58 billion)
  • Vehicles ($52 billion)
  • Machinery ($43 billion)
  • Electrical machinery ($25 billion)
  • Agricultural products ($24 billion)
  • Mineral fuels ($20 billion)
  • Plastics ($13 billion)

Trade talks are expected to resume next week.

S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT Total Return Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

Prepare for a shake up! From Reuters to Marketplace, economic and financial news shows like to ‘do the numbers.’ They often review economic indicators, Federal Reserve rate changes, or benchmark index performance.

In general, these statistics are intended to help people gauge how economies and markets are performing. For instance, when Gross Domestic Product (GDP) – the value of all goods and services produced by a nation during a certain period of time – moves higher, it means the economy grew during the period. When GDP moves lower, the economy contracted during the period.

Asset managers and investors rely on benchmark indices, like the S&P 500 Index, to measure the relative performance of investment portfolios. The S&P 500 is a benchmark for large U.S. company stocks. It includes companies from diverse sectors including:

  • Information technology
  • Healthcare
  • Financials
  • Consumer discretionary
  • Industrials
  • Consumer staples
  • Energy
  • Utilities
  • Real estate
  • Materials
  • Telecommunications services

 

But, wait, change is coming!  Soon, benchmark indices will have a new sector. At the end of September 2018, Telecommunications Services will become Communication Services. The name is changing and so are the companies that will be included in the sector. Ben Levisohn at Barron’s reported:

“The biggest changes will be around some prominent companies that will migrate out of the information-technology and consumer-discretionary sectors and into a new communication-services sector…[The changes] certainly don’t herald any fundamental changes for the companies involved. But they do have the potential to create short-term noise…”

If you’d like to learn about the ways sector changes may affect benchmark indices, give us a call.

Weekly Focus – Think About It
“Progress is impossible without change, and those who cannot change their minds cannot change anything.”
–George Bernard Shaw, Irish playwright

Best regards,
John F. Reutemann, Jr., CLU, CFP®

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Investment advice offered through Research Financial Strategies, a registered investment advisor.

* This newsletter and commentary expressed should not be construed as investment advice.

* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.  However, the value of fund shares is not guaranteed and will fluctuate.

* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.

* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.

* All indexes referenced are unmanaged. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

* Gold represents the afternoon gold price as reported by the London Bullion Market Association. The gold price is set twice daily by the London Gold Fixing Company at 10:30 and 15:00 and is expressed in U.S. dollars per fine troy ounce.

* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.

* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

* Past performance does not guarantee future results. Investing involves risk, including loss of principal.

* You cannot invest directly in an index.

* Stock investing involves risk including loss of principal.

* Consult your financial professional before making any investment decision.

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the subject.

 

Sources:

https://www.cnbc.com/2018/08/31/us-markets-global-trade-tensions-ramp-up.html

https://www.washingtonpost.com/business/economy/nafta-talks-appear-to-sour-after-report-that-trump-disparaged-canada/2018/08/31/56ba2868-ad30-11e8-8a0c-70b618c98d3c_story.html?noredirect=on&utm_term=.15357d0708e8

https://ustr.gov/countries-regions/americas/canada

https://www.reuters.com/finance/markets

https://www.marketplace.org/shows/marketplace/07092018

https://www.investopedia.com/terms/c/contraction.asp

https://us.spindices.com/indices/equity/sp-500

https://www.barrons.com/articles/tech-stocks-could-be-winners-in-big-sector-shift-1535759312

https://www.brainyquote.com/quotes/george_bernard_shaw_386923?src=t_change

 

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