U.S. Stocks Would Bear the Brunt of a Trade War

(Bloomberg) -- The economy would do better by expanding markets than by restricting imports.

Trade-related topics that had been a sleeper have become a front-burner issue for investors. Equity prices and Treasury yields plunged March 23 after the U.S. announcement of a 25 percent tariff on up to $60 billion of Chinese exports. Over that weekend, both sides expressed interest in reconciling differences and markets reversed path when they opened March 26.

If a global trade war erupts, investors should allocate more of their assets to Treasury securities that are likely to experience a further decline in yields. Equities, meanwhile, would bear the brunt of the impact of tit-for-tat trade moves by the U.S. and its major trade partners.

Would the outcome for bonds be different if China, the U.S.’s largest foreign creditor, follows through on its threat to sell some of its $1.2 trillion holdings of Treasuries? Cui Tiankai, China’s ambassador to the U.S., would not rule out this possibility in a Bloomberg Television interview on March 23. Such a move would still not prevent a decline in bond yields because it would also cause global investors to rush to havens.

Happily, there is a path that would reconcile the U.S.’s political objectives and the requirements of global investors. President Donald Trump could achieve his campaign promise of boosting economic growth and creating jobs by expanding markets rather than restricting imports. Such measures would help bring about greater market share for U.S. companies and be welcomed by markets.

The first step was taken by Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer. In a letter to Liu He, China’s economic czar, they asked for a reduction in tariffs on automobiles, increased purchases of U.S. semiconductors, and a further opening of the Chinese financial sector for American companies.

Investor concern eased over the weekend when the official Xinhua News Agency reported that Liu had expressed concern that a trade war would hurt both countries and sought steps to reach a compromise. Exports account for about 20 percent of China’s gross domestic product, and restrictions could significantly slow the pace of economic growth.

The relief of investors is unlikely to last in the absence of concrete measures to open markets. Bloomberg Politics said Tuesday that the Trump administration may restrict Chinese investments in sensitive areas of the technology sector. The report was a major factor in the 2.9 percent decrease of the tech-heavy Nasdaq Composite Index that day.

Nor should investors expect much support from the agreement reached last week with South Korea to allow increased sales of U.S. automobiles in South Korea.

The deal provides no indication whether market-expanding measures will be part of any accord that the U.S. could reach with the European Union regarding tariffs on steel and aluminum imports. The EU has received an exemption until May 1, and U.S. tariffs may yet be imposed if talks do not progress.

The South Korean agreement would also be far outweighed in economic importance by the substantially larger volume of trade flowing between U.S. and China, and by U.S. trade with its North American Free Trade Agreement partners, Canada and Mexico. The three parties are attempting to revise the accord. How these disputes are settled is likely to weigh on the performance of financial markets.

The outcome of these talks will be telling for investors. If tariffs are imposed on German cars entering the U.S.; if Nafta talks collapse; or if China imposes a tariff on a major U.S. export, soybeans; you should sell equities and make Treasuries your friend.

An alternate route would have positive market consequences. An agreement between the EU and the U.S. on a wider market opening for companies would be a major boost to global equities. Also watch whether U.S. companies are allowed to enter Chinese markets without being forced to take on local partners. If it is confirmed that U.S. negotiators have dropped the demand that automobiles must have a 50 percent U.S. content to benefit from Nafta is confirmed, buy North American equities.

Recent market performance shows investors that global trade policy is more potent than the U.S. fiscal stimulus announced in December. Increased allocation of assets to equities has to be based on a clear signal that officials are involved in expanding trade rather than reducing it.


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