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Market Action Update: The “What Now?” Moment

Markets decline on an escalation of the U.S.-China trade war

As of this writing, global equity markets are down in intraday trading by more than 2% today on news that the Chinese will retaliate against the Trump administration’s increase in tariffs by imposing tariffs on U.S. goods. The recent volatility began last week when President Trump announced in a tweet that negotiations over a deal had broken down and that the U.S. would increase tariffs from 10% to 25% on $200 billion in goods from China. After declining for most of the week, markets recovered slightly on Friday on a comment from Treasury Secretary Mnuchin that negotiations were “constructive.” However, defying a call from President Trump not to retaliate, China announced it would retaliate by imposing tariffs on U.S. goods on June 1. A tariff of 25% will apply to 2,493 U.S. products with additional goods facing tariffs of between 5% and 20%. The latest salvo occurred when the Trump administration announced plans to impose 25% tariffs on all remaining imports from China, representing an additional $325 billion in trade.

By way of background, the U.S. runs a trade deficit with China of roughly $420 billion. We import $540 billion worth of goods from China and export $120 billion worth of goods to China. America’s biggest imports from China are electrical machinery, machinery, furniture, toys and sports equipment, and plastics. The biggest exports to China are aircraft, machinery, electrical machinery, optical and medical instruments, and vehicles.

If a trade agreement is not reached, economists at the economic research firm, Strategas, estimate that the existing tariffs could impact U.S. GDP growth by approximately –0.1% for every two months the tariffs are in place, or roughly -0.5% for a full year. Much of the hit to GDP is from reduced confidence and lower investment. The impact on China would be substantial as well, with a hit to GDP of up to -1% per year, though some of that could be offset by stimulus (and the Chinese may be unwilling to report lower numbers). If tariffs are placed on all $500 billion of China’s imports for the full year, GDP growth would be impacted even further – with some economists suggesting an increased risk of a recession.

What now?

That’s the “what.” What about the “what now?” Obviously, things are fluid and we are still evaluating the impact of this news as we speak. But, our take for now is that while the breakdown in an agreement is unfortunate, it’s not an uncommon occurrence in negotiations like this. Game theory suggests that participants will often seek to change their stance or even step away from the bargaining table at the last minute in order to attempt to achieve an advantage over the other party. An agreement was believed to be 90% completed, with only a few remaining sticking points. It’s important to note that a breakdown in negotiation like this doesn’t mean that the parties are starting from square one. While the remaining issues may be thorny, to be sure, it’s at least somewhat comforting that much has apparently been accomplished. And, the good news is that both parties are still talking. Talks resumed this morning and were expected to continue throughout the day. There are even press reports of a potential phone call between Presidents Trump and Xi later today (Monday). 

We still think a deal will eventually be reached. It’s in both parties’ interests to reach an agreement. Neither the Chinese, who are facing a slowdown in growth, nor President Trump – who’s facing an election in 2020 – want to see global economic growth threatened for very long. It’s our belief that this is simply last-minute posturing before a deal.  

Fed on pause helps

We would also note that with the Federal Reserve on hold, at least we don’t have the issue of rising interest rates on top of the trade war to worry about as was the case last year. With the delay in reaching an agreement, and the threat it poses to global economic growth, we believe the Fed is even less likely to raise rates going forward and even more likely that we could even see a rate cut. Moreover, we think it’s more likely that China will introduce further stimulus measures to help prop up its economy, which has become a key driver of global growth.

While our base case for an eventual trade agreement hasn’t changed – the date has merely been pushed out a bit – we nevertheless remain vigilant about alternative scenarios, including a full-blown breakdown in negotiations with no agreement. As we noted in our recent commentary, Early Bloom, this is a possibility. We have already positioned our clients’ portfolios for multiple scenarios. With an uncertain outcome, we’re playing both offense and defense simultaneously. Rest assured that we will remain vigilant about this risk – as well as the many other global macro risks that are out there – and we will adjust our portfolio positioning even further as necessary. But, for now, we remain optimistic that a deal will be done and markets will eventually resume their upward path. In the meantime, prepare for some short-term volatility.

As always, please feel free to reach out to your wealth advisor if you have any questions.

IMPORTANT DISCLOSURE INFORMATION    

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by First Foundation Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from First Foundation Advisors. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. First Foundation Advisors is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the First Foundation Advisors’ current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: First Foundation Advisors does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to First Foundation Advisors’ web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Louis P. Abel, CFA, CAIA, Chief Investment Officer
About the Author
Louis P. Abel, CFA, CAIA, Chief Investment Officer
Mr. Abel serves as chief investment officer, chair of the investment committee and chair of the alternative investment sub-committee for First Foundation Advisors. Through his cumulative roles, Mr. Abel leads the firm’s economic and market outlook and overarching investment strategy – including decisions on strategic and tactical asset allocation, and manager selection. Mr. Abel has over 25 years of investment experience. Prior to joining First Foundation in 2010, he served as senior portfolio manager for U.S. Trust. While there, he was responsible for managing nearly $600 million for individuals, family offices, foundations and municipalities; and served as a member of the Global Wealth and Investment Management Advisory Board. Past positions also include senior portfolio manager for Wells Fargo Private Bank; senior portfolio manager for Husic Capital Management, where he co-managed more than $1.3 billion in assets for clients such as Coca-Cola and Stanford University; and more than a decade with Engemann Asset Management, where he spearheaded the firm’s international investment effort, managing a global equity mutual fund and serving as a member of the investment committee. Mr. Abel began his career as an analyst at Wilshire Associates, where he served on the consulting team for major pension fund clients such as CalPERS and CalSTRS. Mr. Abel serves as an ambassador for Professional Child Development Associates, where he was previously a member of the Advisory Board and Board of Directors. He was also previously the chair of the Finance Committee and served on the Board of Trustees for the Pacific Asia Museum (now named the USC Pacific Asia Museum), and the Board of Directors of Southwest Chamber Music. Mr. Abel completed Stanford University’s Executive Program on Investment Management, earned an MBA in international finance, graduating with honors, from UCLA’s Anderson School of Management, and holds a Bachelor’s degree in economics from the University of California, San Diego. Mr. Abel also holds the Chartered Financial Analyst® (CFA) designation and the Chartered Alternative Investment Analyst (CAIA) charter. Read more
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