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Taking Stock: Globalization Backlash: Tariffs are a Dangerous Game

April 5, 2018 / by Phillip R. Nelson, CFA, Partner, Director of Asset Allocation

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Volatility is back on Wall Street. Stocks sold off sharply on Wednesday morning only to recover by the end of the day as investors regained their composure after being initially spooked at the prospect of escalating trade tensions between the United States and China, the world’s two largest economies.

Earlier this week, the Trump administration outlined tariffs on approximately $50 billion worth of Chinese imports with targeted levies of 25% on 1,300 products, ranging from dishwashers to electric vehicles and industrial robots. The proposed tariffs come on the heels of a levy imposed on Chinese aluminum and steel imports announced last month. China’s response was swift. On Wednesday, it retaliated with plans to impose a 25% levy on more than 100 American products—also totaling $50 billion in imported goods—including soybeans, aircraft and cars. Although a response from China was a given, the targeting of soybeans and aircraft was more harsh than expected, as they account for more than 20% of US exports to China.  

While concerns around a more protectionist US trade policy crystallized relatively recently for equity markets, it has been a major focal point for NEPC for nearly two years. The backlash against globalization, triggered by political discontent and an uneven economic recovery in the developed world, is one of our key market themes. Paired with rising populist sentiment, we see a US that is turning inward, heightening market tail-risks in a shift away from the free-trade economic orthodoxy of the last 50 years. We believe the backlash is a long-term trend, likely leading to higher volatility levels in currencies and stocks, as seen in recent weeks.

At NEPC, we think a full blown trade war—with the potential to radically destabilize the global economy and equity markets—is unlikely. To this end, the US tariffs on China do not go into effect immediately, leaving room for negotiations; there is a period of public comment and consultation expected to last around two months. Meanwhile, the effective date for China’s tariffs on US goods depends on the timing of the US action. It appears both parties desire a negotiated outcome that allows President Xi and President Trump to highlight trade gains to a domestic audience while maintaining overall economic stability between the US and China.

Equity markets often overreact to geopolitical concerns, and higher levels of volatility can be a buying opportunity for disciplined investors. We maintain our overweight recommendation on non-US equities; potential market sell-offs driven by US-China trade tensions may offer an attractive entry point. At the same time, we encourage investors to rebalance “safe haven” fixed-income exposure, such as TIPS and government debt, back to strategic portfolio targets, given the robust performance of equities and credit markets in recent years.

That said, levying tariffs is a dangerous game, which can escalate beyond a negotiating ploy as the demands of domestic politics can diverge from core economic interests. The recent actions against China and the ongoing NAFTA talks have investors taking notice. As always, we will continue to monitor the situation and will communicate any changes in our views. Stay tuned for further developments.

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Topics: Asset Allocation, Blog, Taking Stock, Traditional Assets

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