Three weeks ago it seemed like the world’s two largest economies were getting closer to achieving a deal to end the trade war. However, an increase in tariffs on 200B US dollars in Chinese goods created new tensions in the negotiations. In order to unpack how this will affect your portfolio, the market, and the global economy let’s look at how this all started. This US-China trade war is a microcosm of the general trade policy the Trump administration has with the rest of our trade partners. In early 2018 the government introduced tariffs on solar panels and washing machines on a recommendation from the United States International Trade Commission. In return, China introduced tariffs on a billion dollars’ worth of US sorghum. The Chinese tariffs on sorghum ended in May 2018 and began the series of trade talks that have led to the most recent tax increase. Other notable trade spats have included a tariff on steel and aluminum that had our northern and southern neighbors, Mexico and Canada, along with the EU up in arms. This prompted China to retaliate again through tariffs on 2.4 billion dollars of US goods. This included pork, fruits, aluminum waste, and nuts. The US just recently reached a deal to lift the tariffs on Canada and Mexico that prompted Canada to move ahead with ratifying the larger trade deal set to replace NAFTA. These back and forth hikes and agreements have led to the shaky market environment we have seen in the last few weeks and will have many short and long term implications for you as a consumer and as an investor.
The short term impact of the trade war is one that we have already witnessed in the market. After the May 10th tariff announcement the Dow fell over 500 points and the S&P500 fell about 2% on that day. The volatility came from the signal from both countries that there is no urgency to finalize a deal. The selloff was largely due to the reaction from the news but the broader impact will be seen in portfolios that contain companies with high import costs and heavy reliance on China for sales or production. Companies in the Industrial sector and software goods sector have started to struggle as their overall costs increase. Most recently we saw NVIDIA shares fall after releasing guidance that their earnings will be flat to down for 2019 and 2020. We believe this is a mix of slowing Chinese growth and the increase in operating costs. This trend has been realized as Apple stock was downgraded by HSBC and has been trading down for the last week and a half. Our model below forecasted key items on the financial statements for apple using our assumed growth projections. We concluded that the increased pressure from the decline in growth from China would dramatically affect earnings growth and therefore the valuation.
Even if you do not own Apple in your portfolio, Apple represents a trend in its sector and other equities just like it. Research from Goldman Sachs suggests that multiples compression is occurring through the industries greatly affected by the trade deal. The key financial ratios are going up but due to lack of investor confidence, the stocks are not going up with the good financial results. The research confirms that investors are betting that the trade war is not going to be short and do not want to risk their capital. The short term implications for the trade war are market volatility and uncertain market conditions. However, the long term implications are even more harrowing.
Trade wars are mean to protect the host country’s industry and create jobs, it is a form of trade protectionism. In the long run, trade wars often end up hurting the economies of all parties involved and costing jobs. This trade war is no different, its long term effects will cost both countries jobs and slow economic growth. To throw another wrench in the scenario the United States and China are the world’s two largest economies; therefore, a sustained trade war could dramatically slow global economic growth and plunge the globe back into another recession. So what does that mean for your portfolio?
Here at Nicholas Wealth management, we know that another recession or market correction is a certainty not a probability. The business cycle of the free market allows for periods of growth as well as periods of drought and recession. But the timing and severity of a recession are up to many different factors domestically and globally. The biggest long term concern from the trade war would be a global recession. The average recession loss in a portfolio is 40%, illustrated by the figure below.
The Great Recession: 2008
A recession is the worst possible scenario for a retirement portfolio that isn’t hedged correctly, and as Chinese and global growth slows down it looks like that is where we are headed. Although the US economy is roaring and the market seemed to bounce right back from trade news, the rise of inflation due to tariffs will stifle the rapid growth we’ve had. According to Bloomberg, multiple companies such as Ford, Walmart, Coca Cola, and Proctor and Gamble have already cited the trade war as the cause of their reduced margins. We believe that these costs will be passed onto the consumer. As the consumer price index rises when goods become more expensive investor confidence will follow consumer confidence and the market will become bearish. Price increases in consumer goods and commodities like oil may not immediately affect your portfolio but they will affect your wallet making cost of living go up. As cost of living goes up retirees will be forced to withdraw more from their portfolio to keep up with costs.
As investors and retirees take into account the short and long term effects of the trade war we believe that everyone should have a written retirement plan that helps account for each scenario. Losing 40-50% of a portfolio during a recession could be the difference between leaving money to beneficiaries and running out of money in retirement. Practicing healthy and safe hedging strategies and following recession indicators are a major part of what we do at Nicholas Wealth Management. We make sure that our clients preserve their hard-earned retirement dollars through market losses. If this trade war prolongs we may see a recession as early as 2020 and it’s important to have a concrete plan on what to do if you start seeing those signs.