Is the market overreacting to the trade dispute?
In simple numbers, the US imported $505 billion in goods from China and exported $155 billion to China. This constitutes a net trade deficit with China of $350 billion. This imbalance is the source of President Trump's complaints on the inequality of trade. It is important to remember that the Chinese have recycled this surplus and, as a result, hold a large amount of US Treasuries, keeping borrowing costs low. For many years this has supported US consumer spending; thus a virtuous circle is created where China finance the consumer who buys their products. Trump, with his protectionist attitude, has decided that something must be done, imposing tariffs on Chinese goods and China has responded by imposing tariffs on US goods. There is a period of consultation to go through before these tariffs come into effect and it is to be hoped that a deal will be done to avoid any further escalation of this trade dispute. It is difficult to ascribe exactly what impact this is having since other factors are also at play, but since his first announcement at the beginning of March the S&P 500 US equity index is off about 4%. The US market capitalisation of all stocks is in the region of $25 trillion and a 4% move takes $1 trillion off the index or twice the total volume of trade from China. On this measure it looks like an overreaction. The fear must be that this escalates into a wider dispute and causes inflation while slowing global economic growth. If tariffs cause a rise in inflation in the US, then this could be met by higher interest rates that could impact equity valuations.
Overall, both China and the US have benefitted from global trade and a retreat into protectionist rhetoric is not helpful. If, however, this is a public negotiating stance then markets could be overreacting. While Trump talks of further action, his officials have indicated that they are progressing trade talks and many countries have already been exempted from the steel and aluminium tariffs. While we need to watch developments closely, the reaction so far may turn out to be overdone. Markets are reacting sharply up when there is talk of a negotiated settlement and down when there is talk of wider action. As a result of this, it looks as if we will have to live with higher volatility for some time to come.
What does higher volatility mean in numbers?
Last year the S&P 500 Index of US equities rose nearly 20%. This return was achieved in a very steady fashion with only seven days in the whole year whereby it moved more than 1%. Curiously, for such a positive year, there were more days where the index fell over 1% than when it rose over 1%, four to three. So far this year, the index is down 0.4% having been as high as up 7.4% and as low as 3.4%. We have already seen 26 days when the market has moved more than 1% up or down (compared to the seven throughout the whole of 2018). On five days this year, the index has moved more than 2% when there were no such days last year. With all that volatility, the index at last night's close was off just 0.4% and when dividends were taken into account, it was marginally positive. We expect this volatility to continue and the press reporting of these moves adds to investor nervousness. We need to try and look through the short term noise while being aware of shifts in the underlying drivers of return.
For those focused on the UK the difference is less dramatic, but still evident, with the FTSE 100 index rising over 1% 14 times in 2017 and matching that figure already this year.
Source for figures: Bloomberg, 05 April 2018
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