There’s no room for complacency in the stock market.
That’s why we’ve been warning for months that the U.S.-China trade war is far from over.
The world just got reminded of that yesterday.
On Monday, a couple of surprise early morning tweets from U.S. President Donald Trump emphatically suggested tariffs on US$325 billion worth of Chinese exports would rise from zero to 25 percent by May 10.
Meanwhile, another US$200 billion of Chinese exports already facing 10 percent tariffs would see their tariffs rise to 25 percent.
That effectively ends the four-month trade war truce between the world’s two largest economies.
With the U.S. economy doing well in recent months, Trump seems to feel that he now has leverage to be more aggressive with China on trade.
People say he’s crazy. That he talks too fast. Or that he’s out of his mind. But the gains from his trade recs last year were enough to turn every $5,000 into $1.1 million thanks to one pros-only chart. Now he’s allowing you to join him (and even steal his moves) as he goes live.
He says his next 105% trade recommendation could come in less than an hour. Your chance to join him live is right here.
That’s not surprising. Rule No. 5 in Trump’s tactics for winning negotiations in his book The Art of the Deal states “The worst thing you can possibly do in a deal is seem desperate to make it. That makes the other guy smell blood, and then you’re dead.”
So he’s putting enormous pressure on China to acquiesce to U.S. trade demands ahead of the scheduled trade talks this week in Washington.
Trump timed his tweets perfectly to impact China’s stock market, which fell 5 percent on Monday. That cut the gains on the world’s best-performing stock market to a still-strong 18 percent for the year.
Hong Kong’s stock market, where many mainland China blue-chip companies trade, fell 3.3 percent.
Here’s what could happen next
One of Trump’s major campaign promises in 2016 was to bring China to heel on trade, so he wants to show that he’s making good on that promise.
Even the hint of appearing weak on trade will be detrimental to his reelection efforts in 2020. His base demands a tough stance on China.
Beijing, on the other hand, has made it clear it will not be cowed into submission by threats of additional U.S. tariffs.
And trade talks already appear to be at risk, as Vice Premier Liu He – Beijing’s key trade envoy – is considering calling off his trip this week.
But if Liu He’s trip to Washington is canceled, it virtually guarantees tariffs on US$525 billion of Chinese goods will go up.
That’s certain to trigger a major selloff in the global markets. Last year, China’s stock market fell 30 percent, while other Asia markets fell by more than 10 percent, in part because of trade war concerns. It could happen again.
No one wins when tariffs go up. But if last year is any indication, China will end up being hurt more than the U.S. if they do.
At the end of the day, I think cooler heads will prevail and new tariffs will be averted (at least over the long-term) for three key reasons.
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1. China’s tenuous manufacturing recovery will bring Beijing to the table.
Trump knows the timing is right to tighten the screws on China. That’s because Chinese exports to the U.S. historically start to pick up in the month of May after several months of post-holiday quiet.
While Chinese manufacturing activity (as measured by the Purchasing Managers Index) recovered in March, it weakened again slightly in April. New tariffs would likely push manufacturing back into contraction in May.
Since manufacturing still accounts for 29.5 percent of China’s GDP (compared with just 12.3 percent for the U.S.), Beijing will be hard-pressed to sustain its 6 to 6.5 percent GDP growth target for 2019.
At the recently-concluded Canton Fair – the world’s largest trade fair held in Guangzhou – things weren’t looking up either. Export orders were down 1.1 percent to US$29.6 billion over three weeks.
Higher tariffs at this stage could deal a massive blow to China’s manufacturing sector. That’s why I think Beijing will be more calculated in its response to Trump’s recent threats and want to remain at the table.
2. Higher prices will start to hurt the U.S. economy.
Trump boasts that despite existing tariffs on US$250 billion worth of Chinese goods, the U.S. economy continues to run on all cylinders and that consumers have felt little tariff impact on their wallets.
A big reason for that is the massive front-loading in U.S. orders from China that happened last year in anticipation of higher tariffs this year. It’s why the trade deficit with China grew to a record US$419 billion in 2018, despite the trade war.
But by now, most of those goods have already been sold. That means new imports of these products must be re-priced to reflect prevailing and new tariffs.
Meanwhile, the price of goods so far left out of the trade war (including consumer electronics, apparel and rare earth minerals used in important industrial applications) will see the biggest increases in prices.
The last thing Trump wants heading into an election year is to have an economy that’s losing steam.
3. China’s stimulus programme is just starting to be felt.
We’ve written before that Beijing has embarked on a brand-new stimulus programme designed to help the economy weather the trade war storm.
This stimulus programme differs from past efforts in that it doesn’t involve direct government spending on massive projects.
Instead, it frees up funds banks can lend out to borrowers and consumers, as well as cutting the value-added tax (VAT) on key industries, including manufacturing.
These kinds of stimuli take time to filter down through the economy. So far, we’ve seen growth return to China’s property market.
But its impact also risks being muted by a worsening trade war, as consumers feel less confident about borrowing money. This is another reason Beijing may be more willing to acquiesce to Trump’s demands.
Make sure you’re protected
While a trade deal now seems less likely than it was a week ago, it can still happen.
It’s also possible that both sides work out another extension (it’s happened before) before new tariffs are finally set in stone.
But in case the worst outcome materialises, it’s always important to make sure your portfolio is diversified into different assets and geographically.
Also, make sure to use stop losses on your investments. They help protect your gains during steep market drops, and they limit your losses to preserve your capital for future reinvestment.
Finally, make sure you keep some cash on hand to jump on opportunities that open up during volatile periods.
It’s also important to keep the MSCI inclusion in mind, and its longer-term impact on Chinese stocks.
The MSCI Inc. is a global provider of research-based indexes and an estimated US$14 trillion of assets are benchmarked against the various MSCI indexes.
The announcement in March to hike in China’s weighting in the MSCI indexes is expected to result in as much as US$125 billion of funds flowing into 448 selected Chinese-listed stocks.
This weighting change is going to happen over three phases (May, August and November) this year. It will act as a steady, rising tide that lifts the Chinese stock market.
In short, you don’t need to be frightened by the recent developments in U.S.-China trade relations.
The underlying fundamentals increasing China’s role in the global stock markets remain intact. But make sure you’re prepared for volatility and get ready to jump in when a buying opportunity emerges.
Editor, Stansberry Pacific Research