Judging by market reactions, talks of trade wars appear to be as dangerous as trade wars themselves. With only some initial tariffs being introduced and talks of many more global markets have seen their fair share of volatility over the last few weeks. While the trade war has been a war of words to this point, we’ve been jogging investor’s memories of the historical relevance tariffs have carried.
The protectionist policy concept is not new and GFG Capital believes that recent market behavior is a good indicator that investors have not forgotten what the last full blown trade war initiated by the U.S. brought us. The Smoot Hawley Tariff Act of 1930 sent the global economy tumbling as reciprocal tariffs enacted by U.S. trade partners did nothing to lift economies from depression, but did just about everything in their power to exacerbate the problems. By 1933 U.S. imports dropped off by 66% while exports decreased by 61%. On a global scale, world trade declined by 66% in 5 years before the Trade Agreement Act in 1934. Clearly not something most investors will forget too easily. And it seems they have not, but now D.C. needs to refresh their memory.
We think the market entered the year knowing trade was going to be a focal point of the administration’s agenda. While many might have bucketed this as ‘geopolitical risks’, we don’t think geopolitical risks typically carry true impact to the market. Think about situations likes the Cold War or even as recent as North Korean tensions. What was at stake didn’t carry direct economic implications. What has made these cross border discussions, and tensions, different is the direct impact these discussions and issues have on the global economy.
To this point, these are still just implications. There is no shortage of noise in the last few years, unsolicited nonetheless. But this is the first bit of market noise that has truly garnered consumer attention.
GFG Capital believes that the parties at risk here are some of the key beneficiaries and drivers of the global growth story that has been pushed across headlines so much. So not only do we think these potential victims of initial tariffs posed by the U.S. do everything they can to avoid a repeat of 1930, but they have the leverage necessary to give the U.S. pause.
Most notably targeted has been China. What’s come from Beijing in response to this point has been a calculated, measured response in our eyes. President Xi has the firepower necessary to inflict as much pain necessary to the United States. Although this is not believed to be the MO. China’s initial tariff was much more surgical in nature than expected. Targeting such specific industries that carry direct implications to Trump’s domestic voter base is nothing short of savage. China’s move to create their own TPP deal was a big power move that will carry long term benefits for them as well. So, we’re not surprised to see the U.S. and China trying to hash it out, but we’re certainly relieved. We think China is all in on the long game, and anything that jeopardizes that is not in their interest.
Understanding the web of the trade debate is not an easy task either. The global supply chain is a deeply tangled web in which not all companies report geographical inputs and revenues. Of the 48% of companies in the S&P that do reveal this information, 43% of sales were generated abroad in 20162. The companies that do reveal more granular data indicated that Asia (not just China) accounted for 8.5% of foreign sales with Europe tallying 8.1%3. Energy, tech and materials are the three most globally exposed sectors within the index. If one thinks they are going to untangle this mess to find the few clear winners, good luck.
The trade war hype is the first time GFG is foreseeing a chance for a paper risk to materialize into something real. But they are not running for cover just yet.
This is why some of the tech selloff is being overdone. If it were not for this global tariff scare in the backdrop, then sector rotation would be stepping in a bit quicker. This volatility is what investors should be expecting, but healthy bull markets are carried along by sector rotation. Without it, markets stagnate and health comes into question.
Column by GFG Capital, written by Eduardo Gruener.