Friday, April 6, 2018

"Selloffs can be waved off. However..."

Market researcher Bespoke Investment Group did an excellent job this morning outlining present risks:   emphasis mine...
It is impossible to view the announcement of expanded tariffs by the US last night as anything but a major escalation. Thus far, every tariff announcement by the US has been responded to in similar size with Chinese proposals, so China’s response is likely only a matter of time.

In understanding trade “wars”, the issue for equities is not the specific economic impact of a given proposal but how it fits into the broader context of the negotiation underway. The business models of countless US companies from Wal-Mart to Exxon Mobil to Citi depend on low-friction movement of goods and capital around the global economy. Barriers to that movement force changes in supply chains, have impacts on consumer spending, and lower profitability as well as raising prices. To put this in stock market terms, there is no reason to pay 16.5x next 12 months’ earnings for a US equity market that has to unwind a generation’s worth of cost optimizing and market access expansion. 
Furthermore, huge chunks of global growth are predicated on very long, very complex supply chains. The apocryphal pencil cited by Milton Friedman (link) as an example of Adam Smith’s invisible hand has nothing on the series of complex relationships that result in an iPhone, a car, or other modern goods. Those relationships, once disrupted, are hard to put back together, and this escalating dispute has a nontrivial chance of getting to that point.

The tariffs themselves won’t do it, and they have yet to be implemented, but given that the US exports only $130bn worth of US goods to China, to respond to the latest US escalation China may need to pursue other measures. For instance: punitive regulatory enforcement against US companies, letting non-US companies expand their activity in China, or even expropriation of US-owned property. We should also note that the policy’s defenders seem to argue that the tariffs are just a bluff when they discuss the equity markets, while assuming that the Chinese can’t hear what they’re saying. Best of luck with that.

While the bounce in equities may continue near-term, the US stock market cannot take the implementation of tens of billions of new tariffs on each side of the Pacific with equanimity. US tariffs proposed thus far would not be implemented until May at the earliest, so there’s ample time for another outcome. That’s why selloffs can be waved off. However, as implementation dates approach and rhetoric continues to spiral, it will become increasingly difficult for the market to ignore risks to global activity posed by US policies.

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