“Sequels are Desperate”

                        -Adam McKay

Of the twenty top grossing movies of 2018 only two were not remakes, sequels or part of an ongoing series of films. So far the 2019 box office seems to be following suit. I try to be better, I try to bring you some new content each month and the world usually cooperates by throwing new stuff at us all the time. But this month I have to do my version of a sequel. Last December I wrote an article titled, Trump, China and Interest Rates where I pointed out that the large swings in the markets during the fourth quarter of last year were being caused by whatever the news of the day was regarding those topics. In early May, when the trade talks between the United States and China went off the rails just as an agreement seemed ready to be signed, the markets began to behave much the same as they had in December, just with slightly smaller swings. So let’s dive into this mess and see if we can make any sense of it.

When the Federal Reserve came to a screeching halt in its interest rate increases right after the first of the year the markets reacted very positively. It seemed that these issues I brought up in December, the rate increases and the possible trade war with China, were all behind us; couple that with some strong earnings from many companies and the markets reversed all their losses from late last year by early April. But like a glowing ember in an ash pile caught by the wind, the trade war caught fire again on May 5 ^th when the President tweeted that the Chinese had walked away from the talks and the small current tariffs of 10% on billions of dollars of Chinese goods would be immediately increased to 25% - followed in the coming days by additional tariff announcements by the U.S. and retaliatory tariffs placed on U.S. goods by the Chinese. Depending on what article you read, you can place the blame wherever you want – and where that blame lies has little baring on the economic impact. Tariffs are going to make some things more expensive, hinder some company’s earnings and cost some people their jobs. The markets reaction was actually more muted than I thought it would be perhaps because they expected this to be a hiccup that would simply result in a trade deal a few months down the road rather than never. But as time has gone on, a near term deal seems less and less likely. So what does that mean and what do we do about it?

Fortunately there are a lot of balancing acts in world trade and those are coming in to play in such a way that the impact of the tariffs may not be as large as you would otherwise imagine. The New York Federal Reserve estimated that the tariffs would add $831 this year in costs to the average U.S. family. I’m not so sure about that. What we’ve seen as these tariffs have gone into place is a dropping of the Yuan (the Chinese currency) vs. the U.S. dollar. So while the tariffs are adding 25% to the cost of Chinese goods, the currency devaluation has absorbed about 10% of that extra cost. The price of oil also started to drop at around the same time the trade deal fell apart – slower global trade means less need for oil. A lower gasoline cost could easily offset that $831 in tariff costs for the average family. There is no way to know what the impact of this renewed trade war will actually be because we don’t really know what we’re getting into, and that’s a big part of the problem. Maybe if you’re an internet company that prints up t-shirts it’s easy to switch from your Chinese manufacturer to one in Indonesia or Bangladesh – but for most companies involved in the global supply chain it takes money and time to build new factories and train workforces – whether those factories and workforces are in other developing countries or in the United States. Unless there is clarity on this issue most companies are not going to spend billions of dollars building new infrastructure if there’s a chance of a resolution in six months, or even twelve or eighteen months. If a deal is struck and certain companies realize they can’t make their numbers work while still being in China – or if it is made clear that the tariffs are permanent - only then will you see investment in other alternatives. In the meantime the markets try to adjust projected earnings for companies based on the best guess about what’s going to happen and that best guess changes with almost every scrap of news. 

As I mentioned earlier about blame, the ultimate results of all this could be very good or very bad. China might agree to crack down on intellectual property theft and open their markets to more U.S. goods, or we may see on-shoring of manufacturing to the U.S. which thanks to automation doesn’t bring as many jobs as estimated, but is still good for our economy. There’s also the chance China strikes up deals directly with other counties (or economic blocks like the EU) and the U.S. is left out of large swaths of global trade. Or on the extreme countries start to do business in Euros or Yuan instead of the U.S. dollar and we lose the huge de facto price discount we enjoy for oil and other commodities by all global trade being done in dollars. Of course in the long-run some of these possibilities could be a boon for the U.S. economy while the others could be terrible, but as John Maynard Keynes famously said, “In the long-run, we’re all dead.” Shorter term the trade war is what it is, which is a drag on the economy that may pull us into the recession that the Fed’s change of course had me putting off another 12 months at least. 

We’ve been working with our portfolios and clients to re-position for a more volatile, less positive stock market even before the renewal of the trade war rhetoric. We believe there are enough other warning signs in our economy to warrant such a position, the tariff talk may just be accelerating what is inevitable. But whether we fall into recession this month, this year or not for five more years – we will continue to try and do what’s best for our clients along the way. If you need explanations or reassurance as your portfolio gyrates day to day – please give us a call. If you know someone who needs guidance or reassurance and either has nobody to give it to them, or they are not being given it by their current advisers – give them our name. Until next month – the box office is closed.