As we stated in our 2019 Market Outlook, the U.S.-China trade dispute and the tariffs associated with it would likely be the biggest wild card to investors during the year ahead. Last week that wild card reared its head and did so with unexpected results. Following approximately four months in which markets slowly, but surely, came to the conclusion that a favorable resolution would be reached and an escalation of U.S.-imposed tariffs on Chinese goods could be averted, negotiations ran off the tracks.
As a result, the U.S. has now imposed an increase from 10% to 25% on a total of $250 billion in Chinese imports, with retaliatory tariffs from China announced on another $60 billion of U.S. goods. When the entire amount from both sides is tallied, the total could be north of $600 billion, perhaps casting additional uncertainty on the U.S. and global economies, something not believed to have been in the cards just a couple of weeks ago. On Monday, May 13, the markets reacted adversely to all of this news, with the Dow Jones Industrial Average and S&P 500® declining more than 2% and NASDAQ falling over 3%.
Here are important points we believe need to be taken into account given this surprise development.
- There is still time for negotiations to play out. Despite the fact the Chinese delegation left Washington without a deal and the White House has officially imposed tariffs on the additional $200 billion, they only apply to goods shipped after midnight on May 10. Therefore, based on shipping time, approximately three weeks of inventory remains in the system before the new tariffs take effect on a practical basis. As we also said last January, based on human nature, there was a decent probability that an agreement could be reached simply due to the “cooler heads will prevail” theory that prevents adversaries from going too far down a road detrimental to both of them. So there remains opportunity for more dialogue before the tariffs are actually imposed and real impact is felt.
- The dollar amount of the tariffs is still a small percentage of the U.S. and global economies. When adding up the total amounts of the tariffs — including not just the additional $200 billion escalated last week, but also retaliatory tariffs by China and additional ones threatened by the U.S. — the cumulative amount could be more than $600 billion. While this is certainly a large number, it is important to recognize that this only totals 3.5% of the U.S. economy and less than 1% of the global economy. Of course these amounts are not vanishing into thin air, so incremental impacts to these amounts will, in and of themselves, only have minimal effects on economic numbers.
- Where we could begin to see the effects will likely be in capital spending at U.S. corporations. While the absolute dollars involved in the escalation of tariffs may not appear to be highly impactful, the greater risk lies in overall business confidence and how corporations choose to invest capital amid an uncertain global trade environment. This might originally show up in areas such as nonresidential fixed investment, which tallies corporate investment in areas such as commercial real estate, factories, machinery, and tools. From there, there’s concern that it might spillover into consumer confidence and consumer spending, ultimately impacting the broader economy. So the longer the tariffs remain in place, the more links in the chain there are to watch.
- These tariffs are taking effect against a backdrop of renewed strength in the U.S. economy. Unlike last December, when the prospect of tariffs was taking place during concerns of a potential recession, recent economic activity appears to be strengthening. This would include data such as better than 3% 1Q19 gross domestic product growth (advanced estimate), a 50-year low in unemployment, and rising wages. Unfortunately, these tariffs serve to cast some uncertainty on this newer momentum. However, unlike last December, the prospect of their impact is lessened to some degree by the stronger overall economic backdrop.
- Implementation of tariffs could increase the probability of a Fed rate cut by year end. The immediate concern is the tariffs, if enacted for the remainder of the year, could create a drag on U.S. and global economic growth. While there is much in this ongoing trade drama to be determined before we would concur with this premise, we would also emphasize that the Fed and other global central banks will likely take this into account. With the market debate now centering on whether the Fed’s next move is to hike or cut, any negative impact from tariffs could prove to be a tipping point in late 2019 or early 2020.
At this point we see the tariffs as having a modest negative impact on U.S. economic growth of perhaps .25%–.50% in a worst case scenario of extended imposition into 2020. We would emphasize that given the fluid nature of this conflict, such a scenario may not occur and that higher than previously expected growth could balance out this drag. Fed easing in the U.S. and globally could also be a favorable offset.
Of all the investor concerns plaguing the markets at the end of last year, it seems as though the U.S.-China trade dispute was the last one awaiting some sort of favorable resolution, and market expectations were that it would fall in line like most of the others. The fact it took a decisively negative turn so quickly could continue to create more volatility in the markets and induce additional short-term profit-taking following the strong move stocks have had since the start of the year.
However, given that equity markets are now down close to 5% from their highs of just two weeks ago, the underlying dynamics of the economy remain strong, global central banks are prepared to act, and we continue to view the overall outcome as still potentially resolvable, we would view further material market declines as buying opportunities.
Investments are subject to market risk, including the loss of principal. Asset classes or investment strategies described may not be suitable for all investors.
Past performance does not guarantee future results.
Fixed income investing is subject to credit rate risk, interest rate risk, and inflation risk. Credit risk is the risk that the issuer of a bond won’t meet their payments. Inflation risk is the risk that inflation could outpace a bond’s interest income. Interest rate risk is the risk that fluctuations in interest rates will affect the price of a bond. Investing in floating rate loans may be subject to greater volatility and increased risks.
Equities are subject to market risk meaning that stock prices in general may decline over short or extended periods of time.
Investments in global/international markets involve risks not associated with U.S. markets, such as currency fluctuations, adverse social and political developments, and the relatively small size and lesser liquidity of some markets. These risks may be greater in emerging markets.
Alternative investment strategies may include long/short and market neutral strategies; bear market strategies, tactical strategies (such as debt and/or equity: foreign currency trading strategies, global real estate securities, commodities, and other nontraditional investments).
The information included in this document should not be construed as investment advice or a recommendation for the purchase or sale of any security. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information does not take into account any investor’s investment objectives, particular needs, or financial situation. The value of any investment may fluctuate. This information has been developed by Transamerica Asset Management, Inc. and may incorporate third-party data, text, images, and other content to be deemed reliable.
Comments and general market related projections are based on information available at the time of writing and believed to be accurate; are for informational purposes only, are not intended as individual or specific advice, may not represent the opinions of the entire firm and may not be relied upon for future investing. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decisions.
Transamerica Asset Management (TAM), is the asset management business unit of Transamerica. TAM consists of Transamerica Funds, Transamerica Series Trust, and Transamerica Asset Management, Inc., an SEC-registered investment adviser.