Investors haven’t been this focused on trade policy since 2001 when China joined the World Trade Organization. The shift follows the Trump administration’s recent promotion of tariffs on steel and aluminum, and threats of retaliation from Europe and China.
Trade policy creates a dilemma for any president. On one hand, economists agree that trade boosts economic growth. A poll of U.S. economists by the University of Chicago showed 100% opposition to the recently proposed tariffs. On the other hand, everyday Americans are generally skeptical of trade — just 20% believe it creates jobs, according to Pew Research. These divergent views may be because the powerful benefits of trade higher exports and increased choice and affordability of consumer goods — are spread in subtle ways across the entire economy, while the downside displaced industries and jobs — can be more personal and obvious.
One place trade is not controversial is on Wall Street. Global competition and low cost imports have helped keep inflation low, while larger export markets and global supply chains have boosted corporate revenues and cut costs. Low inflation and strong corporate profits have been a powerful elixir for the stock market, which is why investors have responded to recent trade tensions by selling stocks.
The critical question for investors is whether recent trade tensions will dissipate. A key distinction in this regard is between trade “spats” and a trade “war”. Trade spats are common and involve targeted tariffs on a limited number of goods against a select few countries. Presidents Reagan, George W. Bush, and Obama all implemented targeted tariffs with little notice from financial markets. A trade war, on the other hand, involves tit-for-tat retaliatory tariffs across many goods and industries, and can cause lasting damage to financial markets. Perhaps the most famous example of a trade war began with the 1930 Smoot-Hawley Tariff Act, which deepened the Great Depression.
We expect that because President Trump has previously looked to the rise of the stock market as one measure of his administrations success, he will not wittingly escalate trade tensions to the point of causing lasting damage to stocks. We say wittingly, of course, because these situations can no doubt spiral in unexpected ways. To this end, we will continue to monitor ongoing NAFTA negotiations and the administration’s investigation into Chinese technology transfer and intellectual property theft for clues on the direction of American trade policy.