If there’s any positive to come from US president Donald Trump’s surprise tweet on May 5 that he would level tariffs on another $200 billion of imports from China, it’s that it serves as a wake-up call for investors.
Not only is the year-long dispute between the world’s two largest economies far from over, it could become a full-blown, protracted trade war. Yet asset owners and investors don’t appear to have been sufficiently concerned about this outcome.
Many investors appear to believe the two leaders at the centre of the dispute would and will make rational decisions in the best economic interest of their countries. That assumption fails to consider political and irrational motivations, particularly from the notoriously instinctive US president.
Trump’s policy priorities are often erratic. He possesses few fixed beliefs, has an estranged relationship with facts and is obsessed with media coverage. But in two areas – immigration and trade – he has been almost dogmatically consistent.
Essentially, Trump has for decades believed the US’s trade deficits with other countries are a source of shame, and that they should buy more US goods. He sees China as the chief culprit, and tariffs as the key remedy.
The trade war first erupted early last year when the US president ordered a worldwide 25% tariff on steel imports and a 10% tariff on aluminium imports. Then in June he specifically targeted China, setting 25% tariffs on 818 categories of goods that the US imports from the country. All-told, the affected products were worth about $50 billion annually.
At that point, many Asian chief investment officers adopted a wait-and-see posture.
“Trade friction issues … do not affect our asset allocation that much at this stage,” Public Officials Benefit Association CIO Jang Dong-hun told AsianInvestor in mid-2018, adding that alarm bells would only start ringing if the frictions continue beyond the end of the year.
“At the moment we are in wait and watch mode and not looking to tilt our portfolio one way or another,” said Michael Frith, chief economist and chair of the investment committee for New Zealand Super Fund in mid-last year.
This inaction appeared validated at the beginning of 2019, when the two countries entered a 90-day truce. That led some investors to believe that Trump and Chinese president Xi Jinping would reach an agreement to settle the trade war.
“China will open up more and the US will export more to China. It’s possible that both sides are debating on the details. There will be upsides in the (stock) market when these problems are resolved,” China Pacific Insurance Company (CPIC) group CIO Benjamin Deng told AsianInvestor in February.
Even the White House made repeated claims in March and April that negotiations with Beijing were progressing on track. Then Trump delivered his latest Twitter bombshell. On May 5 he declared the US government would raise tariffs on $200 billion of Chinese goods from 10% to 25% from May 10.
Even that claim failed to persuade some market observers that negotiations had truly soured. They noted the US president had failed to follow up on previous threats.
“It is not clear Trump will follow through with the threat of raising tariffs this Friday– he has pushed back twice on the previous deadlines — in January and in March and it is an all too familiar trick from his playbook to threaten tariffs to speed up negotiations and win concessions,” RBC Capital Markets said in a report on May 6.
And, at the time of writing on May 16, US stocks began rallying again on news that Trump may soften his stance on tariffs. That makes it easy for investors to continue doing nothing.
That would be a form of confirmation bias – a common psychological trait in which people look out for and pay most attention to developments that confirm their existing beliefs.
Investors exhibiting such bias in this particular situation are likely to focus on positive news items and ignore or discount negative items, to avoid the stress of addressing the potential problem of Trump's bellicose trade approach.
The danger is that this leads investors to overly downplay the unpredictability of the trade war in their modeling, while attaching too much importance to positive news developments. After all, a full-blown trade war would be very painful for both countries, and it would be hard to create a fitting investment solution were it to happen.
But it’s the job of responsible CIOs to fully consider such geopolitical risks. It would be wise for them to consider how to best hedge their portfolios against such a sizeable upset.
There is a strong possibility that Trump sees maintaining an aggressive trade policy front against China as a plus to his re-election chances in November next year. He may well also get re-elected to a second term as president, after which he would have no incentive not to act tough against a country he seems to genuinely believe has been ripping America off.
Meanwhile, China is facing more important demographic issues that are causing its economy to slow. Yet despite this, its economy is set to overtake the US’s in the next decade. Given both issues, president Xi may well feel it’s wisest to reinforce his image as a tough leader who doesn’t bow to threats.
The upshot is that while a resolution may be found in the coming weeks or months, today’s trade war could become more protracted and broader, affecting not just financial market performance but the real economy of both nations.
That’s an unpleasant future, but investors need to consider it. It’s always nice to hope for the best – but it’s prudent to prepare for the worst.