Macro Trends/Forecasts

Jeff Miller

"The Man Who Called Dow 20,000" --CNBC

Trade War Update

The daily tweeting and trade news have figured prominently in recent market action.  It is important for investors to search for meaning amidst the noise.  Here are some key themes.

Background

This chart is a nice, clean summary of the US/China story.

Politics

The current policy debate intertwines politics and economics. When this happens, those making political arguments reach for simple symbols to reach economic conclusions.  They play upon existing beliefs, reaffirming them with their viewpoints.

Please note that I am not criticizing this; I am describing it.  If you or I were strategists for these political leaders, we would be assisting them in finding such arguments.

Economics

The economic cost of restrictions on trade is massive.  The annual GDP estimates are currently on the order of a 1% hit on China and 0.6% on the U.S.  And please ignore those who simply take the dollar amount of the tariffs and compare it to the overall size of the economy.  That does not begin to measure the direct effects, not to mention retaliatory moves.

The tariff is paid by the importer in the purchasing country.  The tax incidence is dispersed.  The producer may reduce prices to remain competitive.  The purchaser may absorb part of the tax.  The consumer may pay higher prices.  There can be a substitution effect as suppliers switch to alternative sources (which are only slightly higher in price).

Retaliation can come in the form of tariffs, other regulations or limitations on business, currency moves, or (in China’s case) threatening to sell its US Treasury holdings.

Stating that the impacts are limited is a political argument not supported by economics.  Presidential advisor Larry Kudlow is in the doghouse for some honest answers on TV last weekend. Here are a couple of illustrations.

Today’s news from Seattle illustrates both a loss of immediate sales and future peril.  This is from a major agricultural wholesaler:

That’s bad news for the growers, shippers and packers that Bloxom works with in Eastern Washington — people who, until recently, saw China as a critical market for their massive output. With cherry growers just weeks away from harvest, Bloxom says, “I don’t know how many Chinese orders I’ll have for them.”

And once the buyer seeks other sources…

When tariffs make U.S. farm goods unattractive to foreign buyers, those buyers really do “look for sources elsewhere” in countries, such as New Zealand or members of the European Union, that compete with the United States but aren’t currently involved in a trade war.

And once foreign buyers switch to those new exporters, trade experts say, they’re hard to win back.

The proposals to compensate some farmers do not begin to cover these losses.  In addition, the farmers don’t want payments.  They want to farm.  They rightly have more confidence in the latter source of income!

Your Personal Political Conclusion

Each of us is welcome to favor one policy over another.  Many argue that this is the best chance to change China’s policies on intellectual property.  They also maintain that it is part of a larger global competition.  This may by true.  When the controversy began, I observed that there was a cost to seeking this goal.  Most people did not believe this, so they are getting a real-time economics lesson.

Others contend that last year’s tax cuts have offset any trade war impacts.  That is true for some, but not for most.

While making your political choice, beware of letting your conclusions shape your view of the evidence.

Your Role as an Investor

Putting aside what we feel in our hearts, how should we use our heads to make the best investments?  Here is what we should watch for:

  • Effect on economic data.  Part of the economic slowing, both domestic and globally, reflects the trade war effects and business expectations.  If we expect the war to worsen, this effect may be exacerbated.
  • Headline reaction.  These are rarely accurate reflections of real policy changes.  The algorithms have learned the normal reaction to key words and they trade faster than the humans can.  You cannot beat them in a race, and you don’t need to.
  • Continuing discussions.  If there are meetings firmly scheduled, that is good.  If there is a specific agenda, even better.  If the meetings are set before the G20, better still.
  • Delaying the implementation of new tariffs or regulations, like China’s delay to 6/1 on implementing the latest retaliation.
  • The US backing off on disputes with countries other than China.  There were several signs of this during the past week.
  • Any sign that pressure from GOP constituent groups is finding its way to the White House.

And watch out for instant experts, a species that abounds at the moment.  There are few people able to see inside the President’s mind or the Chinese bureaucracy.  You and I are not among them, so we should pick our experts carefully.

To summarize –

As a citizen, feel free to take any position and argue for it.

As a trader, good luck beating the tweets and the news headlines – and beware.

As an investor, a settlement that ends hostilities would be a plus for financial markets, but do not expect it soon.

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Jeff Miller provides Economic Analysis as well as Market Forecasts as one of the original contributing analysts at FATRADER. A quantitative modeling expert and former university professor who is the #1 Economics contributor at Seeking Alpha, Jeff is regarded as an expert on economics, market reaction to news events, and computer-based trading.
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