Trade Wars and Political Risk

Investors are facing a new risk: A potential trade war.  What changes, if any, should investors make to their strategies?  It’s too early to tell as the course of policy is undefined.  The following is excerpted from my recent letter to investors:

One major cause of the recent volatility is talk of a “trade war” following the announcement of tariffs on steel and aluminum by the Trump administration.  Despite the President’s campaign promises to impose such tariffs, the market was caught off guard by the announcement, perhaps assuming the President would refrain from implementing policies that would pose such obvious risk to economic growth.  Of course, this comes on the heels of threats to pull out of NAFTA and seeking to renegotiate other trade deals, so the news should not have been a surprise.

Nonetheless, discussions are just beginning and nothing firm has been implemented, so calling this a “trade war” is premature.  Perhaps the brinksmanship shown by the President will bring China and others to the negotiating table and resolve longstanding issues such as intellectual property theft and remove trade barriers.  Most countries have little interest in going tit for tat with the US as their economies are more heavily dependent on exports (approximately 20% of the Chinese economy is exports versus around 12% for the US).  However, achieving a favorable outcome will require all parties to skillfully navigate domestic political pressures and complex international relationships.  That’s quite a challenge.

If instead the situation deteriorates into a full-blown trade war, we will likely see damage to multi-national companies as well as the US and global economies.  Decades of free trade has resulted in international supply chains and growth boosted by emerging markets.  Rising input and commodity costs and restrictions on market access will pinch revenues and profits.  Naturally, this would affect stock prices, perhaps significantly.  Our portfolio has little direct exposure to proposed tariffs such as steel, aluminum, autos or agriculture, but if tensions escalate other industries will be impacted either directly by tariffs or as collateral damage.  In short, and in direct contradiction to our President’s tweets, trade wars are bad.

The future course of policy is unpredictable.  The Trump administration lacks direction on this issue to say the least, as evidenced by recent news that the President is considering re-entering the Trans-Pacific Partnership after withdrawing from the agreement in his first days in office (he has since retracted the idea of re-entry).  Given that this is a developing story in the early stages with unknown outcomes, I do not believe significant action in our portfolio is warranted at this time.  Despite the political risks, we do not want to be overly negative with a growing economy, job growth, and record profits from many companies.  Nor should we dramatically alter our investment strategy based on the President’s whims.  However, we must acknowledge that haphazard economic policies increase investment risk and a significant policy mistake on trade could lead to a recession.  I am watching the issue with caution and will update my views as this develops.