May 21, 2019

This past week of elevated market volatility seems to be clearly reflecting a stark new division in trade relations with China and a rising level of future uncertainty about the implications of the new higher tariffs implemented by both the U.S. and China. Investors now know that China is going to hike their existing $60 billion tariff tranche rate from a 5%-10% range to a floating 5%-25% range, starting June 1, in retaliation to the U.S. raising its tariff rate on $250 billion of Chinese imports from 10% to 25%.

As of the closing bell last Friday, there was obviously no deal made, with no sense that either side is about to give an inch on their newly-entrenched positions. China’s President Xi Jinping misjudged President Trump’s zeal to do a deal and also miscalculated how hard his trade team should press American trade representative Robert Lighthizer, who has Mr. Trump’s full trust in the matter.

The fissure in the deal was the U.S. demand that China set forward some changes in its domestic laws so as to achieve accountability standards that senior Communist party leaders saw as “caving in” to the U.S. Sadly, this latest set of circumstances puts the Asian “saving face” cultural syndrome into the global spotlight after China substantially altered the terms that had been verbally settled on at the last minute.

The concern going forward is that because of China’s top-down political structure, it is likely that any new rhetoric out of China will be combative and nationalistic, leaving little room to pick up trade talks where they left off. Without verifiable systems in place to protect and weigh justice against violations, in my estimation, tariffs will be in place for a long time, and, quite frankly, the most important takeaway from this standoff is that China was clearly willing to make promises that it never intended to keep.

Looking at how this trade war will affect China’s future rate of GDP, the Organization for Economic Co-operation and Development (OECD) is forecasting China’s growth rate to slow to 5.5% in 2020, then fall below 4% in 2025 and below 3% by 2030. How accurate are the OECD forecasters? Well, they published an internal report and found that the OECD tended to be too optimistic about eurozone growth. Given China’s current debt-to-GDP ratio of about 300%, it stands to reason that a protracted trade war with the U.S. would only bring those future lower growth rate numbers lower – and sooner than expected.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Emperor Xi Has No Clothes

Now, President Xi has backed himself into a political and cultural corner that has the risk of only getting messier. James Green, who was the top trade official at the United States Embassy in Beijing until last August, said, “Xi has tightened the overall policy atmosphere, so few want to voice opposition,” which means, “that doesn’t leave much room for the negotiators” (source: New York Times, May 16, 2019).

The latest impasse spotlights China’s egregious behavior and puts their duplicity on full display around the world. Once again, we must all learn that doing business on a transparent level with a communist regime is fraught with risk and prone to failure. Now, the Trump administration is preparing to hit China with 25% tariffs on the balance of the $300 billion that China exports to the U.S., while aggressively pushing American and foreign manufacturers to move supply chain operations out of China altogether.

A flight of investment capital from a devalued yuan – which is being manipulated by China’s government to offset the cost of tariffs – and large multi-national businesses hitting the exits to set up shop in other Asian nations is probably the only way China will buckle to terms the U.S. can accept. Until then, the stock market, which only recently set new highs, will be under pressure to reset its growth expectations.

Rate-cut expectations began inching higher, even though Fed Chairman Jay Powell said he does not see the need to move the fed funds rate in either direction at this time. According to the CME FedWatch Tool, the implied likelihood of a rate cut in October increased to 55% from 42%. The fed funds futures market sees a 71% likelihood of a rate cut in December, up from 57.4% two weeks ago, and the odds of a rate cut in January 2020 increased to 74% from 62%, so talk of rate cuts replace previous talks of rate increases.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

What is the bond market telling investors? It’s saying that the U.S. economy will grow, but at a slower pace. To me, this means that investors should allocate more capital to defensive blue-chip stocks paying high dividend yields, and to stocks that are growing their dividends aggressively. Under this scenario, capital flows into those areas that will likely be the most bullish, because they’re the best game in town.

And when I say, “in town,” I mean “in the whole world.”

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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