US-China trade negotiations reach a critical juncture, ratcheting up market volatility

A perspective from E*TRADE Securities 05/10/19

For the past few months, the Trump administration has hinted that the US and China were on the cusp of a groundbreaking and historic trade deal. The markets have surged on even the slightest hint of progress in the negotiations, no matter how scant the details, but no agreement has emerged.

Like a desert mirage, the ephemeral prize evaporated yet again this week. Emboldened by a strong jobs report and historically low unemployment, President Trump on Sunday took to Twitter to threaten China with increased tariffs on $200 billion worth of goods. Stocks sold off after the tweet and remain underwater for the week.

What’s at stake in the negotiations?

At issue is how to wind down a trade war that has been simmering since the Trump administration slapped $250 billion in tariffs on a wide range of imports from China last year.

The US has long accused China of predatory pricing—dumping exports in the US at prices so low that domestic manufacturers can’t compete. To be sure, China is known for protectionism—subsidizing industries its government views as vital and going to great lengths to shield its markets from foreign competition.

Although China has attempted to moderate its trade policies in recent years, it hasn’t been enough to assuage US concerns about unfair trade practices and intellectual property theft. The result has been an escalating trade war that may not subside even if a trade deal is reached.

The role of tariffs in the trade war

President Trump, who once branded himself “Tariff Man,” views tariffs as a primary source of negotiating leverage and has made liberal use of them against both adversaries and allies.

But while tariffs have figured prominently in US trade policy of late, many economists believe they are economically damaging. That’s because tariffs are taxes on imports that ultimately get passed onto producers and consumers.

Just as important, tariffs frequently result in retaliatory measures that can hurt exporters. Soybeans, which make up 60% of US agricultural exports, have been one of the more visible examples of this phenomenon. After China responded to US tariffs by restricting soybean imports from the United States, US soy export volume cratered. The USDA estimates it could take a decade for soy exports to return to 2017 levels.1

US soy exports may take a decade to recover

Data source: U.S. Department of Agriculture


Trade gap with China hit an all-time high in 2018

So far, the tit-for-tat has garnered mixed results. In February, the US total trade deficit in goods and services narrowed by 3.4% to $49.4 billion, driven in part by an improved balance of trade with China and rising shipments of civilian aircraft, passenger cars, and medicine. Still, the trade gap with China isn’t far off last year’s pace, when it ballooned to a record $419 billion.2

US trade deficit with China, 2009-2018

Data source: U.S. Census Bureau


Potential investment strategies for a trade war

For investors, the ongoing US-China trade war carries no shortage of risks in the form of threats to economic growth. But opportunities can also be found:

•  Look for protected industries: It stands to reason that the winners in a trade war could be industries that the US is attempting to protect. So far, the Trump administration has slapped some of the stiffest tariffs on Chinese steel and aluminum producers. Other targets include makers of semiconductors, construction equipment, washing machines, and solar panels.

•  Be wary of companies dependent on Chinese imports: While companies protected by US tariffs can benefit, downstream manufacturers that rely on inputs imported from China have taken a hit—in particular, steel-dependent equipment makers. Conversely, while farmers have been hurt by lower soybean and crop prices, these same trends can benefit agribusiness firms that buy agricultural commodities.  

•  There’s an ETF for that: Just like smartphone apps, exchange-traded funds (ETFs) come in nearly every shape and size. There are even ETFs that invest in market segments specifically affected by US government policy and regulation. Some of these funds have been positioned to capitalize on the ebb and flow of US-involved trade wars.

As we’ve seen over the past year, the markets are sensitive to any news around US-China negotiations, and investors can pay a high price if talks appear to have stalled. As such, it’s always a good idea to maintain a diversified portfolio of holdings—including high-quality fixed income assets than can help buffer against market volatility.

Also, bear in mind that when a trade resolution is finally announced, it may still take a while for the agreement to be ratified. Even then, investors will need to do some digging to see how much, if anything, has really changed.

The devil is in the details, which, so far at least, are nowhere to be seen.

1. United States Department of Agriculture, “USDA Agricultural Projections to 2028,” March 2019, https://www.ers.usda.gov/webdocs/publications/92600/oce-2019-1.pdf?v=3630.9

2. United States Census Bureau, “U.S. International Trade in Goods and Services, February 2019,” April 17, 2019, https://www.bea.gov/system/files/2019-04/trad0219.pdf

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