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

8 Things to Know About the USA-China Trade Dispute

The headlines are filled with rumors of a trade war between the United States and China. You’ve probably heard by now that both nations have announced tariffs on many of each other’s goods.  This has many economists concerned about a trade war.  A trade war, in case you’re not familiar with the term, is “an economic conflict in which countries impose import restrictions on each other in order to harm each other’s trade.”
In response, the markets are doing their best impression of a see-saw – falling and then rising again.  Because this story probably won’t go away any time soon, let’s break it down.

Eight Things to Know about the USA-China Trade Dispute

ONE: The U.S. has announced tariffs on almost $50 billion in Chinese exports.1
The list, which stretches to over 1300 items, includes goods like medical equipment, chemicals, televisions, and automobile parts.1  This is on top of an earlier spate of tariffs on Chinese steel and aluminum.  However, many of the most commonly-used goods Americans use, like shoes, clothing, and phones, are not included.

TWO: China has retaliated with tariffs of their own.
On April 4, China announced plans to levy a 25% tariff on roughly $50 billion worth of American goods.1  This includes airplanes, cars, soybeans, and other vegetables.  Earlier, China had already declared tariffs on $3 billion worth of agricultural exports, like fruit, nuts, and pork.

THREE: The two countries aren’t actually in a trade war – yet.
Notice how often I’ve used the word “announced”?  As of this writing, none of these tariffs have gone into effect yet.  The U.S. intends to hold public hearings sometime in May, and has 180 days after that to decide whether to go through with the tariffs.2  China, meanwhile, has avoided mentioning any specific dates.  It’s possible both sides are hoping to engage in talks before the tariffs are in place.  If successful, there’s a chance the tariffs never will.
In other words, a trade war has been declared, but the “fighting” hasn’t started yet.

FOUR: Both sides see the situation very differently.
It’s safe to say neither country wants a trade war – hence the delay.  But that doesn’t mean negotiations will be simple or easy.

The issue, at least from the U.S. administration’s standpoint, is a $375 billion trade deficit2 with China, which many see as being due to unfair or even illegal trade practices.  China has a long history of forcing American companies to share their technology in order to do business there, making these companies less competitive than they might otherwise be.  In some cases, Chinese companies are alleged to have outright stolen American intellectual property.  The administration believes that tariffs will stop these practices and reduce the deficit.  China, of course, doesn’t see it the same way.  The Brookings Institution, a well-known think tank, describes it like this: “From Beijing’s perspective, the U.S.-China trade imbalance is a result of many factors—automation, evolving global supply chains, increased competitiveness of Chinese firms, the Federal Reserve’s normalization of interest rates, and the Congress’s deficit-increasing tax cuts. Because the trade balance is the difference between savings and investment, Beijing also views U.S. fiscal and monetary decisions as contributing to America’s overall trade deficit—including with China.”3

Overcoming this basic difference in opinion will probably need to happen before the two countries can strike a new deal.

FIVE: Trade wars can impact markets…
Again, we’re not yet in a trade war.  But should these tariffs go through, history suggests it will have an impact on the markets.

Tariffs are a tax on imported goods and services.  They essentially make it costlier and more difficult to import certain things, like metals, foodstuffs, consumer products, and so on.  That can be a major boon to industries that produce those same things, because it forces consumers to buy domestically.  On the other hand, China’s tariffs could make it harder for U.S. companies to sell their own goods.  For those companies that do a lot of business in China, this can have a major effect on their bottom line.  As a result, some companies’ stock price could suffer.

SIX: But that doesn’t necessarily mean the markets are going to plummet.
To give you an example, take this past Wednesday, April 4th.  When the markets opened, the news out of China caused the Dow to drop 510 points.  But the Dow rallied later in the day, ending up 300 points.4

While a trade war can be unsettling for investors, it’s important to remember that the day-to-day movement of the markets is based on many factors.  Trade is only one of these.  The overall economy is still doing well, unemployment remains low, corporate earnings continue to be solid – you get the idea.

The point is, the U.S.-China trade dispute is important, but not the be-all and end-all.  It’s something to keep an eye on, but not something to overreact to.  And again, we’re not yet in an actual trade war!  If history is any judge, there will be a lot more twists and turns to this story.  A lot can change over the next few weeks and months.

SEVEN: This is an opportunity to practice discipline.
The markets are in the habit of jumping at the slightest sound – but we’re not.  We rely on the news to stay informed and up-to-date, but not to dictate our every decision.

As a financial advisor, I can’t tell you what President Trump will do, or what China will do, or whether a trade war will happen.  I can say that we’ll keep seeing a lot of headlines on this.  Remember the see-saw metaphor?  As the situation develops, it’s not unlikely the markets will continue to rise and fall as investors digest the news coming out of Washington.  For that reason, it’s wise to expect more volatility – but let’s bear in mind that volatility doesn’t equal catastrophe. 

All this means we have a wonderful opportunity to practice discipline.  To avoid getting caught up in the day-to-day.  To not let headlines – and the emotions they evoke – control us.  The more we do this, the more we’ll keep moving toward our goals.

EIGHT: We here at Research Financial Strategies are monitoring your portfolio.
This is our job: to monitor your portfolio.  If at any point we feel the trade situation could harm your holdings and impede your progress towards your goals, we’ll let you know immediately.

In the meantime, remember: My team and I love hearing from you!  Please let us know if you have any questions or concerns.  Our door is always open.  Have a great month!

1 “All the Goods Targeted in the Trade Spat,” The Wall Street Journal, April 5, 2018.  https://www.wsj.com/articles/a-look-at-which-goods-are-under-fire-in-trade-spat-1522939292

2 “U.S. Announces Tariffs on $50 Billion of China Imports,” The Wall Street Journal, April 3, 2018.  https://www.wsj.com/articles/u-s-announces-tariffs-on-50-billion-of-china-imports-1522792030

3 “How to avert a trade war with China,” The Brookings Institution, February 27, 2018.  https://www.brookings.edu/blog/order-from-chaos/2018/02/27/how-to-avert-a-trade-war-with-china/

4 “Trade war? Not so fast. Why stocks are rallying again,” CNN Money, April 5, 2018.  http://money.cnn.com/2018/04/05/investing/stocks-rebound-trade-war-us-china/index.html