The trade dispute between the US and China has escalated in recent weeks amid the Trump administration’s threat of tariffs on $300 billion more Chinese imports and sanctions on Huawei, the world’s biggest maker of telecom equipment. Following the announcements, developed market equities fell 6%, emerging market equities lost 9%, and government bond yields shed 0.2% to 0.4%.1 Markets have partially rebounded, but I believe any potential resolutions over the next few months will likely be temporary, and that tensions between two of the world’s largest economies could be a lingering headwind for global markets.
A 2018 Gallup poll showed that Americans think China’s trade practices are deeply unfair (FIGURE 1). This would appear to translate to the popular support for President Trump’s “tough on China” approach. Add to that current bipartisan enthusiasm in Congress, and I think markets should expect further trade disruptions.
Importantly, a widening scope elevates the uncertainty around tariffs and may increase market risk premia broadly. The Trump administration seems to be in favor of using the levies not only to narrow large trade deficits, but also as a tool for settling disputes outside the economic realm: Chinese human rights, for example, or Mexico’s approach to illegal immigration. Even if an agreement is reached, if the US were to deem China noncompliant, it could use it as an excuse to take additional action.
An intensifying trade war increases costs for consumers and businesses and will continue to disrupt global supply chains—both of which are negative for global growth. Although a de-escalation of tensions with China, including the possibility of compromises or other solutions, may occur in coming months, I think the cycle of new tariffs, retaliatory measures, and negotiations at the margin will continue. Investors should expect markets to remain volatile as a result.
Americans think China’s trade practices are unfair
Americans’ views of fairness of trade policies by country
Note: Poll conducted between June 18 and 24, 2018. The poll asked participants: “For the following countries, please tell me if you believe each has a fair trade policy or an unfair trade policy with the United States.” The chart above only shows the “Fair” and “Unfair” responses, leaving out the minority of responses for “Don’t Know / No Opinion.” Therefore, the responses for each country in the chart will not sum to 100% but are still representative of “Fair” and “Unfair” views. | Source: Gallup.
Given the potential for slower global growth, consider more defensive portfolio positioning:
- US equities could outperform other regions
- Within the US, quality and safety-oriented factors may be attractive
- Maintain investment-grade credit exposure
- Increase duration* with US government bonds
“Diversify” from China:
- Consider increasing exposure to countries, industries, and companies whose revenue and supply chains are less dependent on China
- Globally, sectors such as defense, healthcare, and telecommunications tend to be driven more by local markets and demand sources
Be selective within China:
- Domestic-oriented sectors, including education, travel, financial services, and healthcare, are likely more insulated from trade risks.
1 Equity returns start on May 3, 2019 (following the new tariff and Huawei announcements) and end at the recent bottom for each representative index as follows: June 3 for developed-market equities as measured by the MSCI World Index (a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets) and May 23, 2019 for emerging-market equities, as measured by the MSCI Emerging Markets Index (a free float-adjusted market capitalization-weighted index that is designed to measure equity market performance in the global emerging markets). The date range for government bond yields, as measured by US and German 10-year government bonds, is May 3 to June 3, 2019. Past performance is not a guarantee of future results. Indices are unmanaged and not available for direct investment.
*Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.
Important Risks: Investing involves risk, including the possible loss of principal. • Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets. • A focus on investments in particular sectors, geographic regions or countries may result in increases volatility and risk of loss if adverse developments occur. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Diversification does not ensure a profit or protect against a loss in a declining market.
The views expressed here are those of Nanette Abuhoff Jacobson. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.