The last few weeks have seen an uptick in trade tensions between the US and China. The world’s first and second largest economies seem to be on the brink of escalating the trade war further, and there doesn’t appear to be any way to avoid major economic pain.
President Trump’s move to jack up tariffs on Chinese made goods from 10% to 25% sent global equity markets lower, but this is probably just the beginning of major problems in the global economy.
If China decides to answer back with any number of countermeasures it has been sitting on, the trade war may begin to seriously disrupt almost every part of the global supply chain.
It is telling that Chinese President Xi Jinping visited rare earth companies after the trade talks in the US fell apart. He was joined by Vice-Premier Liu He, China’s lead trade negotiator in the US-China trade war. China controls most of the world’s primary production capacity for rare earth elements (REEs), which are vital for the manufacture of almost every form of electronic technology.
An export ban on REEs is only one of the ways that Beijing could answer President Trump, all of which would serve to stomp global economic activity into the ground.
If Huawei is a Page From the Trade War Playbook, We are in Big Trouble
Huawei was in the news last week because President Trump banned US businesses from doing business with the world’s second largest smartphone manufacturer. In the wake of the “Huawei Ban” Google had to suspend their access to Android updates, which would’ve effectively made the current generation of Huawei the last one to be compatible with the Android ecosystem.
President Trump then issued a 90 day waver for Huawei, which allowed Google to continue to work with the Chinese electronics conglomerate. Huawei may have dodged a bullet last week, but if we look at the progression of political actions against the company, it sends a chilling warning to the global economy.
The US under President Trump has been hard on Chinese businesses.
The CFO of Huawei, Meng Wanzhou, was arrested last year in Canada after the US ‘asked’ Canada to do so on its behalf. She is still being held in Canada and is fighting not to be extradited to the US. The US Department of Justice is also going after Huawei at a corporate level and has issued unsealed indictments that include at least 23 counts of intellectual property theft.
US-led actions against Huawei date back to 2012, although the effective ‘kidnapping’ of the world’s largest telecom equipment provider’s CFO seems like a ‘next-level’ move.
You don’t need to be Adam Smith to know that if the world’s two largest economies have turned hostile towards one another, there are going to be some real consequences. The material impact from the trade war has been limited so far, but the pain that John Deere is feeling is likely going to spread to the wider economy over the rest of 2019.
The Chinese have been importing far fewer agricultural products from the US, which has left US farmers in a lurch. The net result has been lower prices for grains as stockpiles grow, and rising suicide rates in agro-dependent areas.
While the US could seem like the global tech hub, the actual equipment manufacturing happens mostly in Asia.
Apple may be sweating the latest round of tariffs, as importing Apple handsets from its suppliers in China is about to get a lot more expensive. There is also a rising tide of anti-Apple sentiment in China, which had been the luxury smartphone manufacture’s largest growth market.
Tearing Out The FAANGs
The FAANGs have been one of the biggest drivers of the stock market’s massive, decade-long rally. Apple was valued at more than a trillion USD and is still worth more than $800 billion at the time of writing.
Over the course of a few weeks, Apple products have become a subject of ire and scorn in China. There is now talk of an ‘Apple Ban’ in the Middle Kingdom, which would annihilate Apple’s bottom line. The US has publicly humiliated Huawei, and now it appears that Chinese nationalism may take a bite out of Apple.
Amazon has a lot to lose from the simmering trade war as well. So far, there hasn’t been a major knock to consumer spending from falling trade, but the tariffs that Trump is slapping on just about everything coming out of China will start to affect the price of consumer goods soon.
All those consumer products that are produced in China will be going up in price, at the same time that global growth is sputtering. That seems like a pretty rough situation for anyone connected to retail spending, which is how Amazon makes its money.
The big US tech names can survive for a while in a bad market, but their high-flying stock prices aren’t as likely to be as resilient.
The 1987 Crash All Over Again
Stock market investors had it good for a while. The last decade has been a time of steadily rising equity values, and relatively low volatility. That looks set to change, though many investors are still clinging to the hope that recent market performance has engendered.
It is easy to forget that equity valuations were supported by the idea that Donald Trump would be a ‘pro-business’ President. 2018’s melt-up was obviously fueled by the expectation of better corporate earnings via lower taxes, but it looks like equity investors are once again behind the curve.
Even at an institutional level, there is the hope that somehow the global economy will escape from President Trump’s mad dash to protectionism, which historically has been a precursor to actual war. Buying stocks that are built to function in a world where there is open trade and sane leadership won’t work in the current environment.
If things continue to worsen in the geopolitical arena, current equity valuations will seem like a fairy tale in retrospect. While there is nothing wrong with optimism, when the two largest economies are hell-bent on antagonizing each other, it is time to see the risks that go along with the situation.
There is no way to know if the US and China are actually going to start a military conflict, but the idea that this escalating trade war won’t have a severe impact on the global economy is absurd.
Look Out Below
The time is right for a big move lower in equity prices. Over the past week, bond prices have exploded higher, which isn’t good news for stock market investors.
Major equity indices are still within 10% of their all-time highs. These valuations seem like a stretch given the rapidly worsening global trade situation. There is no telling how quickly the US-Sino trade situation will disintegrate, but we probably saw the high water mark for global integration sometime between 2005 and 2015.
This view isn’t understood in the wider investing community, most of whom are hoping that things will just go back to the ‘new normal’, and the long, slow melt up in equities will continue.
Equity values may fall slowly, but a one-off panic revaluation is far more likely.
The big difference between 1987 and today is that once equity values fall, they probably aren’t going to bounce back in a few year’s time. Unless, of course, central banks really pump the gas, and we see a Zimbabwe-esque rally in asset values–otherwise known as hyperinflation.