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Investment Commentary

photoMarch 27, 2018

War! What Is It Good For?

Philip Hergel, Senior Quan­ti­ta­tive Analyst

The clas­sic anti-​war song of the 1960s “War” per­formed by Edwin Starr for Motown records was intended as a protest against mil­i­tary con­flict dur­ing the war in Viet­nam. The singer’s bold and defin­i­tive con­clu­sion that war is good for “absolutely noth­ing” is equally applic­a­ble to the mis­guided pol­icy of trade wars. Yet here we are in the early days of this exact pol­icy blun­der, which has been con­demned as short­sighted and destruc­tive by vir­tu­ally every econ­o­mist, polit­i­cal sci­en­tist, busi­ness leader, and elected offi­cial — save one: Pres­i­dent Trump.

As we look out over the next year at pos­si­ble events that might dis­rupt the cur­rent bull run in global equi­ties, an esca­lat­ing cycle of tar­iffs levied on goods imported into the United States fol­lowed by retal­ia­tory puni­tive actions by its trad­ing part­ners is high on our list of con­cerns. A trade war is indeed good for noth­ing except pos­si­bly allow­ing the Pres­i­dent to brag about how effec­tive he is at imple­ment­ing his cam­paign promises.

The real­ity of trade wars is that they are extremely destruc­tive and costly for all play­ers involved. The global econ­omy is a com­plex sys­tem that has evolved over cen­turies to be a utility-​maximizing and cost-​minimizing machine. There is a very good rea­son why low-​tech man­u­fac­tured goods tend to come from China: they have an abun­dance of work­ers will­ing to per­form their tasks at a much lower rate of pay than west­ern work­ers. Like­wise there’s a very good rea­son Canada exports so much electricity-​intense alu­minum: they have abun­dant hydro-​electricity and the infra­struc­ture nec­es­sary to pro­duce the metal. Sim­i­larly, the U.S. has a high con­cen­tra­tion of top-​tier schools and a large, diverse, edu­cated, and entre­pre­neur­ial pop­u­la­tion. It makes per­fect log­i­cal sense for the U.S. to be the power cen­ter of the tech­no­log­i­cal rev­o­lu­tion. If the global sup­ply chain were to be dis­rupted, as occurs in a trade war, and each coun­try had to pro­duce what the other coun­tries can do more cheaply and more effi­ciently, the end results would be declin­ing pro­duc­tiv­ity, ris­ing costs, and weak­ness in global eco­nomic activ­ity. Just how much the global econ­omy dete­ri­o­rates would depend on the breadth and dura­tion of trade restric­tions. Recent global equity mar­ket weak­ness is a sig­nal that earn­ings would be neg­a­tively impacted should trade ten­sions con­tinue to escalate.

One of the clos­ing lyrics of Edwin Starr’s great song says: “Peace, love and under­stand­ing. Tell me, is there no place for them today? They say we must fight to keep our free­dom. But Lord knows there’s got to be a bet­ter way.” We at Zevin Asset Man­age­ment believe cooler heads will pre­vail and the “bet­ter way” will be rec­og­nized. Our base-​case out­look is for ten­sions to sim­mer down. Thought­ful diplo­matic trade nego­ti­a­tions in response to the severe neg­a­tive eco­nomic and finan­cial out­comes of a trade war are likely to resume. That said, we also rec­og­nize there is a non-​trivial pos­si­bil­ity of pro­longed destruc­tive trade con­di­tions. One of the found­ing prin­ci­ples of Zevin’s invest­ment process is to plan for the unlikely and as such, we are con­sid­er­ing how best to pro­tect clients’ port­fo­lios by ana­lyz­ing assets, regions, and indus­tries likely to be least affected by a pro­longed trade war.

Mr. Hergel cur­rently pro­vides the quan­ti­ta­tive mod­el­ing inputs which help to drive the asset, coun­try, and sec­tor allo­ca­tion deci­sions within our port­fo­lios. Pre­vi­ously, Mr. Hergel spent 12 years with BCA Research (for­merly the Bank Credit Ana­lyst), a well-​known and respected inde­pen­dent invest­ment research and advi­sory firm, where he was respon­si­ble for their econo­met­ric mod­el­ing efforts. Mr. Hergel holds an under­grad­u­ate degree in Sta­tis­tics and an MA in Eco­nom­ics from Con­cor­dia Uni­ver­sity in Montréal.