Philip Hergel
Senior Quantitative Analyst
Here we go again! As Trump 2.0 initiates Trade War 2.0, the stage is set for what might be a far more punitive retaliatory tariff cycle compared to what we experienced during Trump’s first Presidency. For starters, in the rest of the world there’s already a coordinated effort to fight back against President Trump’s tariff strategy, including boycott lists of American products as well as identifying specific American products for retaliatory tariffs. Trade negotiations outside of the U.S. are already underway in order to dampen the blow of the trade war with America. Global leaders are especially incentivized to band together today as Trump threatens to “get Greenland” from Denmark, “take back” the Panama Canal, “make Canada the 51st state”, and “take over” the Gaza Strip. Meanwhile, on the other side Trump has become more emboldened due to his re-election victory and the groveling he’s enjoying from within his party. Both sides are quite likely to dig in their heels this time and the results could be far worse in terms of economic and geopolitical outcomes.
In early 2018, as the first trade war erupted, we wrote about the potential economic damage caused by those lame-brained trade policies. We include below that memo again today since the story hasn’t changed; tariffs are contrary to healthy, sustainable economic growth. As the Brookings Institution put it, there’s more pain than gain to be had in a trade war. https://www.brookings.edu/articles/more-pain-than-gain-howthe-us-china-trade-war-hurt-america/. In fact, a quick glance at corporate earnings shows a significant leveling off of S&P 500 aggregate earnings per share during the last trade war. It’s difficult, if not impossible, to tease out the trade war effect on corporate earnings from general economic conditions, but as we wrote in 2018 below, the overwhelming consensus view from experts and policy makers is that trade wars are good for absolutely nothing.
War! What Is It Good For?
The classic anti-war song of the 1960s 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 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.
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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.
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