3 June 2019
Best Time to Consider International Exposure in the Midst of the Trade Drama
Investors have dealt with a back and forth of rising tariffs from both sides of the U.S.-China trade dispute, with the ball currently in the Americans’ court, as the Trump administration is currently studying whether to raise tariffs on the final and largest tranche of Chinese imports. The near-term impact on the market is easy to see, but determining the longer-term economic impact more difficult. That said, multiple recent studies—including by the National Bureau of Economic Research (NBER) and Goldman Sachs—have basically settled the question of who bears the greatest cost of the tariffs … U.S. companies and their consumers do. At this stage, our friends at Cornerstone Macro estimate a drag on U.S. GDP of -0.30% based on already-imposed tariffs, with a significant 0.4% additional jump expected if the remaining proposed tariffs on $325 billion of Chinese imports are imposed.
Those estimates are largely based on the direct impact of Americans paying higher prices (a “tax”) due to the tariffs. We are also concerned about the hit to corporate confidence and the attendant halting of forward capital spending plans. The consumer-led growth part of the economic cycle is already rolling over; and the hoped-for next leg of capital spending growth is being dashed. For now, despite a modest pullback, business confidence remains fairly high (especially among smaller companies); but most measures haven’t taken the latest rise in trade tensions into account. Already, we’ve seen the ISM Manufacturing Index indicate that manufacturing executives are growing more concerned about the trade uncertainty; with the key leading indicator of new orders in decline. We’ll be watching confidence, and capital spending plans, closely as the trade tensions drag on.
Corporate confidence dented but remains elevated—for now
What is uncertain at this stage is the more dominant trait of President Trump: retaining his self-proclaimed “tariff man” status at any cost, or the desire for a second term as President? The latter would suggest a lofty incentive to reach a deal; however, there are two sides in this battle, and China is making it increasingly clear they are playing a long game and won’t be “bullied” (their word) into a deal. In the meantime, it’s our job to try to assess the economic and market implications of the tariffs to date, without trying to game or forecast an unknowable outcome.
The trade news is not all bad. Earlier in May, the Trump administration announced it was delaying a decision on auto and auto parts tariffs, which would have had added the European Union and Japan to the trade battle.
Economic data on the back burner, but should not be ignored
With trade taking up much of the oxygen in the room, recent economic data may have been overlooked by many investors. There were some recent releases that added to our concerns about the near-term trajectory of economic growth. First quarter real gross domestic product growth (GDP) was stronger than expected, but boosted significantly by inventories and net trade; both of which are expected to reverse in the second quarter. Since that release, we got the April readings on industrial production and retail sales; which were both big misses, at -0.5% and -0.2% month/month, respectively.
Fed still supportive
In the midst of all of this the Federal Reserve remains in pause mode; after becoming significantly more dovish since the January Federal Open Market Committee (FOMC) meeting. However, there remains a yawning gap between the market’s expectation of a 90% likelihood of a rate cut by year end and the Fed’s official forecasts, which suggest the next move will be another hike. We believe economic data would have to deteriorate much more for a rate cut to come to pass near-term—and as usual, the convergence between the market and the Fed could contribute to volatility in the coming months.
In general, the markets seem to subscribe to the notion that there are no winners in a trade battle. By staying out of the fight, a country or region may be able to avoid collateral damage. U.S. and Chinese companies may bear the brunt of the costs of their ongoing trade battle.
Trade tensions will likely continue to contribute to increase volatility and the longer it drags on, the bigger hit to economic growth, consumer/business confidence and the stock market. Our neutral stance around U.S. equities suggests keeping allocations no higher than longer-term strategic targets, with a large cap bias; using volatility for rebalancing opportunities. For those investors who don’t have broad international exposure, now may be a good time to consider areas that may feel less impact from the U.S.-China trade dispute.
Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research