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Q&A: What is a Trade War and How Could it Affect the Stock Market?

by | Apr 6, 2018

If you’ve tuned in to the financial media recently, which we usually do not recommend, you’ve surely seen talks and fears around a “trade war” between the United States and China. We’ve already begun to see tariffs being imposed by both sides and market volatility has been the result. But, what is it all really about? What is a tariff? Why is this impacting the stock market and why do people care?

First, to understand what a trade war is, you need to understand what a tariff is. A tariff is a tax imposed by one country on imported goods or services from other countries. A tariff is used primarily to discourage or restrict imports from other countries. By raising the taxes on such goods, they become less attractive to consumers, wholesalers, etc. Tariffs can be applied as a fixed fee or percentage of an item’s total value.1

In this case, the United States is imposing tariffs on goods imported from China to protect domestic industries and to get China to improve its trade practices with the United States. According to CNN.com, the U.S. imports $505 billion in goods from China and only sends $130 billion in goods to China. In a perfect world, it seems that tariffs would help domestic companies. However, tariffs can also have negative side effects.

Critics of Trump’s tariffs say that China has the upper hand on the United States where trade is concerned. Thus, they would have more leverage in an all-out trade war. If this is true, negative effects could be seen by U.S. businesses that import goods from China.

Trade War Timeline

As of the date of this article being published, here are the sequence of events that have occurred:2

April 2017: President Trump launches investigation into steel imports.

August 2017: President Trump launches another investigation to evaluate any unfair trade practices with China, specifically targeting alleged Chinese theft of US intellectual property. The U.S. government later estimated that intellectual property theft by China is costing the U.S. “between $225 billion and $600 billion” every year.

January 2018: The United States announces 30% tariff on imported solar panels, which mostly come from China, and taxes on large residential washing machines starting at 20%. China, South Korea, and Mexico were among 3 countries who expressed their dissatisfaction over the decision.

February 2018: The U.S. Commerce Department proposes a range of tariffs on goods including steel and aluminum. The U.S. Steel industry was in favor of the proposed tariffs, but some U.S. business leaders feared it would lead to a trade war. China said it will “take necessary measures to defend our rights” if it is hit with tariffs.

March 9, 2018: President Trump follows through on proposed tariffs, taxing imported steel and aluminum at 25% and 10%, respectively. Canada and Mexico are exempted from the tariffs. China called the tariff a “serious attack” on international trade and vows to take “firm action” if Chinese businesses suffer losses as a result.

April 2, 2018: China imposes tariffs on U.S. imports worth around $3 billion, which included products like fruits, nuts, wine, and steel pipes.

April 3, 2018: The U.S. announces potential tariffs in response to the August 2017 investigation into Chinese intellectual property theft. Taxes would be imposed on goods from the aerospace, machinery, and medical industries.

April 4, 2018: The Chinese government announces another set of retaliatory tariffs that mirror Trump’s proposal from April 3rd. The products on China’s list include aircraft, automobile, and soybean products. This announcement hit companies like Boeing and General Motors hard, with those stocks declining by 6% and 4%, respectively.

What does this mean for the stock market?

Our perspective on the trade war is that it is yet another “crisis” or event that can have short-term effects, but does not necessarily change our long-term strategy. It is our view that regardless of what the financial media is featuring as the crisis of the month, we believe that a solid investment approach still includes diversification, internal cost management, and a long-term outlook. The potential trade war may have short-term consequences, but part of managing investments within the strategy of your overall plan means proactively planning for negative short-term events.

How is that done? We accomplish that by recommending a cash reserve or a partial allocation to fixed income investments for short-term needs. Investing in equities should most likely be part of a financial plan with a mid to long-term time horizon. And historically, stocks have shown much resilience over long periods of time when faced with a multitude of negative economic events, including wars, financial crises, bursting bubbles, etc.

If you invest in the stock market, it should be expected that the market will experience volatility and some years will show negative performance. That doesn’t make it any easier to stomach, but it should be expected all the same. The financial media has a track record of amplifying certain events that may happen in order to increase ratings. This has made it difficult for some investors to stick with their strategy in those volatile times.

If that sounds like you, we would encourage you to first talk with your advisor to review your plan. Then, you may want to turn that television off and ignore the financial headlines.

1 Source: https://www.investopedia.com/terms/t/trade-war.asp
2 Source: http://money.cnn.com/2018/04/04/news/economy/trump-china-us-tariffs-trade-timeline/index.html

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