PMC Weekly Review - June 29, 2018

A Macro View: The Global Trade Predicament: Positioning America’s Knights, Pawns, Rooks, and King

A game of global proportions is taking place on Wall Street right now….and contrary to what the large crystal LCDs flickering in the background of several prominent trading desks would suggest, it’s not the World Cup. Rather, it’s a centuries-old game of whist and precision, two parts strategy and one part luck. And quite serendipitously for our discussion this week, some historians believe it originated in China.

The market has been rattled this June over concerns of a global trade war. Investors fear that President Trump’s proposed tariffs could lead to retaliatory measures from trading partners around the world, which in turn could foster a global recession. These concerns have been echoed by the European Union and China, each of whom faces the possibility of growing and costly tariffs. The US has threatened China with tariffs on up to $250 billion of its imports, and Europe with heavy tariffs on metals and imported cars, which combined could affect more than $300 billion in commerce, prompting these countries to take action together and respond in kind. And, the reverberations of this threat can already be felt across the markets, with the US, European, and Chinese markets declining in unison. Notably, the yuan, which typically trades within a tight band to the US dollar, hit a six-month low on Wednesday and sent Chinese stocks rattling to official bear market territory, as the Shanghai Composite slid more than 20% from its January high. With China and Europe being such considerable market forces, let’s hope our rook and pawn are up to the task of holding their ground against their two knights, or we might be in a bind.

It certainly seems like all parties involved have a lot to lose at the table, with consumers left wondering whether they themselves will turn into sacrificial pawns as fears over higher prices and inflation ensue. Some companies like Harley Davidson have already responded creatively, announcing plans to build their motorcycles for European clientele overseas, but it is hard to envision a scenario where at least some portion of global trade cost is not absorbed by the average household.

Of course, this game of Chess does not have the benefit of taking place in a quiet room isolated from outside variables and patrolled by ardent tournament directors. Indeed, many other ‘noises’ in the background duly influence the health of the market and economy overall. Among the leading indicators this week, domestic initial jobless claims rose more than expected, increasing to 227,000 from the previous week’s report of 218,000. US GDP growth also rang in lower than expected, with a report of 2% for the first quarter of 2018, in contrast to market expectations of 2.2%, and driven largely by a decline in business inventories and personal consumption. The housing picture remained robust, with new home sales in May increasing 6.7% to 689,000. And, the price of a barrel of oil continued to climb, hitting a three-and-a-half-year intraday high of more than $73 a barrel on Thursday, following earlier reports of a decline in Canadian and Libyan inventories and the US’s call for its allies to cease all Iranian oil imports by November.

Also noteworthy, Justice Anthony Kennedy announced his retirement from the Supreme Court on Wednesday, effective July 31, paving the way for President Trump to choose the second Supreme Court Justice since he took office. Justice Anthony Kennedy was long considered a swing voter, and if the President holds true to his campaign promise, our nation’s highest court likely will be shrouded in a veil of conservancy for decades to come.

Overall, whether the President’s trade tactics will prove to be an act of brilliancy or a massive blunder is difficult to say at this stage in the match. Trade protectionism certainly seems like an antiquated notion in a day and age of free trade, where global walls have largely come down and countries have embraced a model of producing goods and services where they have a competitive advantage and/or economies of scale. However, as with Chess, even decisions that require one to anticipate an opponent’s move ten steps in advance can sometimes fall prey to more chance than circumstance. A fair number of unknown variables make it almost impossible to calculate with any precision what the impact will be on financial markets, due to the range and complexity of the scenarios involved. Accordingly, it may be a wise course of action to remain invested—albeit with additional consideration for investments that offer hedging, inflation protection, or unique diversification properties—and to continue to recalibrate portfolios as new data become available. Nonetheless, we can take comfort in the idea that the global economy is not a zero-sum proposition but rather a delicate balance where each country will protect the most valuable pieces on its board. 

Cynthia Crandall, CAIA
VP, Senior Investment Analyst

Source: Bloomberg

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