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Weekly Market Commentary – August 26, 2019

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Global stocks were having a positive week until an escalation in the trade war between the U.S. and China pushed the market lower Friday morning. The S&P 500 dropped 2.6% on Friday after the president indicated the U.S. would respond to additional Chinese tariffs.  For the week, the S&P 500 dropped 1.4%. Global stocks also declined as the MSCI ACWI slid 0.5%. The Bloomberg BarCap Aggregate Bond Index rose 0.1%.

calendar year (august)

Key Points for the Week

  • China and the U.S. ratcheted up tariffs on each other’s goods as the trade war intensified.
  • A deal remains the most probable outcome, but the risk of an elongated trade war continues to increase.
  • Market volatility has increased in August as investors are reacting to news on trade amid slowing economic growth.

Sometimes a Tweet can be Quite Loud

“The problem with trade wars, like shooting wars, is once they start, you never know how they’re going to end. The enemy gets a vote, and sometimes events escalate in an ugly fashion.” — Wall Street Journal Editorial, August 24, 2019

Last week marked a further escalation in the trade war between the U.S. and China. The exchange of tariffs and sharp words continues to raise the risk of an elongated trade war and has concerned many investors. (A summary of the tariff back-and-forth can be found in the section below. This section will focus on the potential outcomes.)

The most probable case remains that a deal will be reached. The economic incentives encourage deal-making, but other possibilities remain. Below is a summary of potential scenarios and whether they became more or less likely based on last week’s news:

  • Great deal for both sides: The probability the U.S. and China will reach a great outcome has likely declined. Both countries seem to be escalating their reactions rather than seeking to press toward a negotiation. The language has become more personal, which makes it harder to reach a strongly beneficial agreement.
  • Mixed deal prior to the U.S. election: Paradoxically, the rapid ramp-up in policy response has made a deal of mixed quality more likely. Both economies are slowing, and the trade disputes are a significant cause. The U.S. and China are more likely to seek a deal this year to calm markets and provide stability for companies involved in trade. The deal will likely have flaws that the two sides can begin wrestling over almost immediately, and some tariffs may remain.
  • Long negotiations: This scenario involves a rollback of threatened tariffs and extended negotiations. Given the recent escalation, the odds of this arrangement have declined. The Chinese favor this approach because they believe they can get a better deal if Trump is not reelected. The Trump administration’s emphasis on trade will make it a major election issue, and the president seems to be prodding the Chinese to make a deal. Based on the administration’s actions, they will drive toward either a quicker mixed deal or negotiations will devolve into a…
  • Major trade war: Because both sides seem intent on one-upping the other’s responses, the risk of this scenario has increased. The consequences for stocks in the short-term are expected to be negative if this scenario occurs. Economic growth in China, the U.S. and the rest of the world would drop, and the risk of recession would continue to increase.

At some point, the economic pain should push the U.S. and China to come together. Conflicting objectives, internal political pressure and personal attacks keep raising the hurdles to an agreement. The risk remains the trade war will continue to escalate. If it does, the uncertainty from trade will affect exporters in both countries and continue to spread to other industries and other countries.

U.S. companies are being encouraged by the president to relocate production to other areas. Companies have already started to move some production, but it will be a slow process. China has great strength in factories, a well-educated workforce and infrastructure that makes the process easier for companies to do business there. Other countries may have cheaper labor but lack the strengths China has. Those capabilities can be gained, but not immediately. Unless negotiations reach a deal, the souring U.S.-China relationship will be felt by companies across the world.

As the accompanying chart shows, volatility has returned to the market. There have already been nine days during which the S&P 500 moved more than 1% in either direction. That is above average and is also the highest total for any month this year, and there is still a week to go. As long as negotiations are stalled and tariffs continue to escalate, investors should buckle in for a bumpy ride.

What Happened: A Summary of Recent Trade News

In response to slow progress on negotiations, on August 1, the U.S. announced a tariff increase on nearly all goods shipped from China currently without a tariff. Some of those tariffs were later delayed until the middle of December, in order to avoid raising prices on goods just before Christmas. The Chinese responded by allowing their currency to decline relative to the dollar, cancelling out some of the negative effects of the tariff. In turn, the U.S. labeled China as a currency manipulator.

The downward spiral in the relationship seemed to pause, until Friday, when the Chinese announced new tariffs on $75 billion of U.S. goods. Trump responded angrily via Twitter and the U.S. then raised tariffs by 5% on many Chinese goods already under tariff.

Fun Story

Taylor Swift’s Asset Restructuring

The U.S. and China’s trade negotiations are proving difficult and perhaps the U.S. needs a better negotiation team. Taylor Swift may be the right person. Part of the royalty rights to her songs were purchased by an investor for $300M who Ms. Swift evidently doesn’t like. But those royalties are tied to specific recordings of the songs that were on the original albums. This gives Ms. Swift the opportunity to rerecord the albums again and less the value of the original rights substantially. She appears to be moving forward with the plan.

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