By SA Marketplace :
It's always tempting to extrapolate from the latest headlines and say ' this is a turning point.' Many seized on the market sell-off in early February as a sign that the long-awaited bear market was finally setting in, quick to ignore the fact that the market 'bottomed' at levels last seen three months ago. Twitter's ultimate contribution to society may be how much it makes us all look like idiots in the moment.
The Trump administration's announcement Thursday about the implementation of tariffs on imported steel and aluminum has felt like a shift in the market dynamic. Though President Trump campaigned on a more restrictionist trade policy, many in the markets hoped that it would be more bluster than reality, and that tax cuts and less regulation were the most important policies to focus on.
The final tariffs were viewed as watered-down , but they're also feared to be the first shot fired in a global trade war. So what's an investor to do, head to the mattresses or shut off the TV and focus on their garden? We asked a few Marketplace contributors whose areas of focus spread from macroeconomics to asset allocation to industrials (the most apparently affected sector by the news) to ask them what they think of the news and what might result.
SA: What is your view on tariffs as a policy?
Michael Boyd, author of Industrial Insights : Tariffs, by their nature, create inefficiencies. As a consumer, it pays to be anti-tariff. If China is dumping steel below cost, that means finished products made with that steel within our borders are being sold to consumers below cost. For the United States, that also means we're "exporting" the environmental impact that often inevitably accompanies industrial activity. With wages stagnant for many, tariffs increasing costs on Americans make for an easy political talking point.
While the narrative is that we need to protect our aerospace and defense industries, the section 232 Ruling stated that the U.S. military requirements for steel and aluminum represent only 3% of total U.S. production. It is incredibly small. If this a national security issue, the U.S. government can support production via above-market long-term contracts with quality suppliers or through targeted tariffs or quotas.
Given the support for a blanket tariff, I worry about far-reaching impact. While this is fundamentally about trade, my concerns are on the impact for value-add producers further down the production chain. Aerospace and defense is a massive industry that helps our trade balance: we exported $146 billion in 2016 within this category. It is very easy to see a case where this political stance can cause more harm than good. Even without widely-expected retaliation, higher manufacturing costs by extension means lower demand for exports.
Eric Basmajian, author of EPB Macro Research : Tariffs are a controversial economic policy. Whether they are a good policy or not depends on what ideology and economic beliefs you hold. If the goal is to maximize global economic output, at the expense of job-loss in some countries, then tariffs are a bad policy and free trade would likely result in the greatest total global economic output. If the goal is to revive a certain industry to bring back jobs, tariffs are a necessary policy.
In the United States, there is absolutely a trade problem that needs to be addressed; the non-petroleum trade deficit has reached a record high so President Trump is certainly feeling pressure to act on this campaign promise. I am not sure this exact tariff is the best policy, but it is likely to go through nonetheless.
Non-Petroleum Trade Deficit:
The goal of this tariff to target steel industry manipulation by China, specifically the subsidized steel dumping through Canada. Steel and Aluminum only represent 1.5% of US imports and 1-2% of global trade. This specific tariff will not have large impacts. However, the retaliation and escalations of trade wars are what will impact markets.
As a general rule, the country with the largest trade deficit has the upper hand and the leverage in the negotiations. Put another way, Germany's exports as a % of GDP are 46%; South Korea, 42%; Mexico, 38%; Canada, 31%; China, 20%; and the United States, 12%. If all trade stopped tomorrow, the United States is hurt the least in terms of impact to GDP simply due to relative domestic demand. The United States does have the leverage in this negotiation. The specific industry, steel and aluminum are not a large portion of global trade so the market is likely overreacting. As retaliation attempts intensify, more market dislocations are likely.
William Koldus, author of The Contrarian : This is a loaded question. Tariffs are a tax, which is a negative; however, many governments and central banks are involved in providing subsidies and protection to various industries. Tesla ( TSLA ) is an example, in the United States, of a company that has received and benefited from government largesse. Thus, when is "free trade" really free trade?
Joseph L. Shaefer, author of The Investor's Edge® : Tariffs are not an economic policy. They are a political contrivance, a political convenience, a political negotiating tactic and, sometimes, economic suicide. See Smoot-Hawley 1930. (In fairness, in that case, the US placed tariffs on more than 20 THOUSAND products from abroad.)
Eric Parnell, author of The Universal : I am someone that believes in policies to improve the prospects of domestic manufacturers. Having worked as an economist in anti-trust and trade issues in the past. However, I am someone that is strongly against tariffs as a policy to achieve this goal, as they work directly against promoting long-term economic growth and prosperity.
Tariffs are likely to lead to higher input costs not only for those manufacturers that import these inputs but also for those that rely on domestic production, as these prices are likely to rise as well in response to the pricing shift in the marketplace. These higher costs are likely to be passed along at least in part to customers, thus resulting in an indirect tax on businesses and consumers. Moreover, such protectionist trade actions have historically resulted in retaliation in kind by foreign governments, thus further dampening growth and resulting in additional negative pricing effects. While such policies may be well intended, they invariably end up being counterproductive in working to achieve their intended goals.
Kirk Spano, author of Margin of Safety Investing : Well, the short answer is that tariffs generally don't work well and have unintended consequences. History is ripe with those lessons. However, people often feel as if some foreigner has wronged them, so they support these usually counterproductive measures.
Certainly, in rare circumstances, very directed measures can be taken to counter a bad actor, but in those situations, the tariff is a last resort as other measures, such as domestic subsidies or bilateral trade negotiations are usually more productive.
SA: How important is this to the market? If it is important, is that because of the tariffs itself, or because of side effects - retaliatory tariffs, Gary Cohn stepping down, other?
MB: I think it's a major issue, if only for the potential cascade side effects and unintended consequences. It's a recipe for global uncertainty and volatility, which by extension puts equity valuations (for the market as a whole) at risk. American indices remain risk-off, but that can easily change if dominos begin to fall. The prospective retaliatory tariffs levied by the European Union show that this isn't just an "America versus China issue".
EB: This specific tariff is not important to the market as steel and aluminum only make up 1.5% of US imports and 1-2% of global trade. All the analysis of this specific trade tariff only shows changes in global GDP growth of a fraction of 1%.
The impacts of this tariff are the ancillary effects, including retaliation tariffs and other ways of 'getting even'. The United States has the least to lose in this trade war due to the high deficit and low exports as a % of GDP.
The United States has the power to get quite aggressive in this trade war, and that is likely the biggest risk to the markets. This specific tariff is not likely to have a large impact, and the market is likely overreacting in the short run. The retaliation attempts will be the big disrupters, but those are yet to be seen, so we have to see the extent of other countries reaction before we are able to analyze their impacts. Maybe other countries realize the United States has the upper hand and the leverage in this trade war and do not retaliate too harshly.
I do not expect this to escalate into a full blown trade war.
WK: The importance to the market directly is very minimal, as Wilbur Ross displayed with his impromptu television infomercial, which even reached me, and I hardly watch financial television. Global steel prices have been in an uptrend for several years now, and China's growth has accelerated from its 2016 nadir, so it has been exporting less steel, since it has been using it domestically. Overcapacity in the steel and aluminum sectors remains a problem. However, for both steel and aluminum, the global markets are much improved from where they were in 2016. Indirectly, the market is going to extrapolate what this means in the bigger picture, so the indirect impact is more important, though I believe this indirect impact has already been overstated.
JS: Not terribly important. If this question were about importance to the economy, that would be a different matter. However, the market in recent months has withstood the shocks of spiraling US debt, Fed rate hikes, negative GDP reports, the discovery of massive Chinese stockpiles of metals and other commodities in Canada and Mexico, declining retail sales, rising oil and gasoline prices, a market air pocket and rising interest rates to name but a few. I am sad to see Mr. Cohn, as a voice of reason, resign - but Goldman Sachs ( GS ) is quite willing to send any of a hundred Cohn Clones to ensure Wall Street's interests are represented in the White House.
EP: I believe the tariff issue is one that is critically important to the market and is one that, to date, the market has been vastly underestimating, in my view. Many investors have proceeded with the assumption that the recent tariff announcement is more bark than bite and that the final policy will be vastly watered down if not discarded altogether. But many signs from a rhetoric and administrative staff shuffling perspective suggest that the protectionists in the executive branch in Washington have taken the reins on this policy issue, which is one that the President has been advocating for some time. Put simply, this is likely the beginning of a policy development that has the potential to offset a good deal of the corporate earnings momentum generated by the recent tax cut legislation. And with stock valuations already at historical highs at a time when central banks are increasingly taking away the stimulus punchbowl, this is bound to lead to great stock price volatility going forward if nothing else.
KS: Gary Cohn leaving is somewhat concerning as he was the voice of the global liberal trade system that has generated trillions of wealth for America and pulled billions out of poverty. We have to remember, that since the free trade agreements started to proliferate, the global economy has done very well, with some hiccups of course, an occasional crash and the problems with too much flowing too few.
What doesn't make sense about the steel and aluminum tariffs is that it was done blanket style when its very common knowledge this is about China. Why alienate allies again the way it was done? At least they are opening a path to exemptions, which I pointed out in Will Protectionism Be Different This Time? was vital.
Going through the process of granting exemptions though is burdensome and requires more government, which is the opposite of what the Trump administration says it wants. It doesn't make sense.
If these tariffs, both the steel and aluminum tariffs, and the solar and washing machine (does anybody get the strategic importance of that?) tariffs, lead to a broader abandonment of free trade, such as us leaving NAFTA, then we are on the way to a very big economic and financial shock.
Imagine what could happen to the companies in the S&P 500 ( SPY ) that export. What does it do to the smaller domestic companies that rely on supplying or building for the multinationals.
I'm in a manufacturing state, Wisconsin, I think we rank like 3rd or 4th for manufactured goods. I have talked to about a dozen business owners now, each one scared because they remember what happened when President George W. Bush passed steel tariffs. They all slowed down.
SA: How does this affect your approach to the markets and the areas you focus on in your investing?
MB: Rather than buying levered American steel producers like AK Steel ( AKS ) or prospective beneficiaries from increased domestic production like Cleveland-Cliffs ( CLF ), which I view to be a crowded trade, I think investors should take a little more of a global view. European steelmakers make for compelling short targets since volume not flowing to the United States likely goes elsewhere. European producers like ThyssenKrupp ( TKAMY ) or Voestalpine ( VLPNY ) are at risk to see margins collapse after finally achieving marginal profitability recently after the cyclical downturn. Given my bullish view on U.S. markets and bearish take on Europe, this type of trade is all the more compelling. For evidence of that divergence, just take a look at the difference in returns between the German DAX and the S&P 500 in 2018. Expect that kind of performance to continue.
EB: This does not impact my approach to markets or the investments we make at EPB Macro Research. The approach we take is purely data-driven. If these tariffs have an impact on markets, we will see that reflected in the economic data and react accordingly. For now, I do not anticipate these recent changes to shape the path of global economic conditions. If the trade war intensifies, that could change but for now, any large scale impacts seem premature.
WK: Tariffs are likely to add to inflationary pressures, and this is a significant boost for inflationary assets, which I continue to favor today, when very few investors and speculators actually believe inflation could take hold, even though global sovereign interest rates appear to have made their secular bottom in 2016.
JS: It doesn't. I will still survey the domestic and international environment every morning and tweak our portfolios and recommendations for my readers' due diligence accordingly.
EP: Having been at a maximum allocation to stocks in my broadly diversified asset allocation strategy for some time, I have since shifted toward a focus on booking profits and dialing back exposures on the margins. I am also emphasizing even further a focus on value and defensive allocations within the stock allocation. I am also taking a risk-off stance more broadly, recognizing the ability of China in particular to retaliate against tariffs from a financial markets perspective given their sizable position as a major foreign holder of U.S. debt. In short, depending on how contentious the trade issue becomes, it has the potential to become messy for financial markets as a consequence.
KS: I was already cautious because we are near the end of the bull market cycle with monetary conditions getting tighter, earnings peaking and buybacks having their final bubble blow. If there are trade impasses, I hesitate to say trade war, then that's another headwind against what I have termed the " slow growth forever " global economy that will have to fight aging demographics and massive global debt for at least three more decades.
I am being a lot more careful about being in companies that are highly dependent on the free flow of trade and a growing GDP. There are few broad indexes I want anymore as this has become even more of a stock pickers market. I really want to stay with the change agents in technology that are growing to the move to "smart everything," the value currently in energy, a few other growth stories in industry and consumer goods, and a handful of dividend paying value plays.
SA: At the risk of putting you out on a limb, do you think the Trump administration enacts the tariffs, and what happens next? ( Editors' note - this question was sent out Wednesday, before the tariffs were formally announced Thursday. Keep that in mind with respect to the responses)
MB: I'm not surprised to see Donald Trump favoring the blanket global tariff option on steel and aluminum. The Trump Administration is not known for nuance; something that Republicans and Democrats see in vastly different lights. Republicans see that ideology as pulling no punches on the global problem of "free trade" that isn't really free; Democrats see it as bullying tactic by someone that doesn't understand the problem.
I don't see Donald Trump reversing course. He has publicly moved against Paul Ryan and other Republican allies on this issue. Taking steps backward now after taking such a public stand, in his view, would be a sign of weakness in his leadership. He was elected as the President that would finally follow through on campaign promises; trade protection was a core plank of his platform.
EB: Yes, I do think that these tariffs are enacted in some form. Perhaps they are not passed at the rates or levels at which they were originally stated. President Trump typically starts his negotiations high and settles slightly lower but time will tell.
As I said in my previous answers, I do not think this specific tariff will have a major impact. There are, however, a few key points I would like to bring up that are not addressed often.
The loss of jobs in the United States does not end with the closing of a factory in terms of economic impact.
The labor force participation rate for prime age workers, 25-54, is declining. That is a very troubling sign to have prime age workers out of the labor force. As more prime age workers leave the labor force, government social benefits increase, and these are costs that are not factored in to the economic impact of a lost job due to global trade.
Labor Force Participation Rate Ages 25-54:
Source: BLS, EPB Macro Research
There are massive economic impacts from a decline in prime age workers that are difficult to calculate but should be considered when determining policy. The first question to think about when determining policy is whether the goal is to do what is best for the United States or is the goal to maximize global trade and output.
WK: The tariffs are a negotiating starting point, and while it has caused a bunch of ink to be spilled, I do not think it changes the bigger picture narratives, with respect to stocks, bond, and commodities. Two of these aforementioned asset classes remain historically overpriced, and one of these asset classes is historically underpriced, both on an absolute and relative basis.
JS: I imagine, to quote a great market forecaster somewhat before his time, "it is a tale told by an idiot, full of sound and fury, signifying nothing." Various idiots across the political spectrum will swear the world is ending because of the immediate retribution of the rest of the world, or because members of Congress pandering to their big re-election donors were not consulted for their known-in-advance viewpoint, etc. What happens next is that the USA will use this global reaction to extract concessions from its #2 and #3 trading partners, Canada and Mexico, to stop being a stalking horse for its #1 trading partner, China and to serve notice upon China and any other nation that would try to game the system that the system here can play the game as well or better.
EP: I do think that the Trump administration will enact the tariffs largely as stated. And I think this may just be the beginning of an increasing wave of tariffs that roll out in the months ahead across a variety of goods. The stock market reaction thus far has been surprisingly muted. But the irony in this lack of reaction is the fact that perhaps the one thing that might cause the White House to stand down from more aggressive action on the tariff front would be a more immediate and swift negative market reaction to this new trade policy. Put simply, the longer the market does not react to this increasing shift toward protectionism, the more imbedded it is likely to become with potentially more pronounced negative ramifications for the U.S. and global economy going forward. It should be interesting to see how it all plays out.
KS: We heard last night that there will be tariffs but with pathways to exemptions or exclusions. Like I said, that's a burdensome and slippery slope. There is a lot of room for error and retaliation.
If I were a betting man, and I am, you know I play some high level poker, I'd say we get some unintended consequences and see an economic slowdown by the first quarter next year.
Thanks to our panel for their insights. If you're interested in their work, you can follow their accounts or check out their services below.
What do you think happens next? Is this just a negotiating stance or the first step towards a spiraling trade war? A mountain or a molehill? How does this affect your investing approach? Let us know below. It seems, at least, like we are entering interesting times.
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