Brass Tacks

One of the more difficult things about investing in a Trump Administration is the constant state of distraction. It is all too easy to get caught up in day-to-day antics and lose perspective of the stuff that will really matter in the long run. It’s a constant battle.

This week, we want to ignore the constant noise that is Washington, D.C. and re-focus on what will matter in the long run. This is, and has always been, about China. Since China entered the world economic stage back around 1980, it has been a massive success story, as defined by the very rapid economic growth the Chinese economy has enjoyed since then. They got there by utilizing their labor cost advantage; borrowing and investing heavily; and exporting goods around the world. Of course, the U.S. was complicit as the drive for cost efficiency pushed our manufacturing to a lower-cost solution, without concern regarding longer term risks.

Many are unaware that China has not consistently adhered to the terms of major U.S. trade deals in the past, particularly with respect to purchase commitments and structural reforms. While trade between the two nations has grown, with China being the biggest beneficiary, compliance issues have been a recurring source of tension and have contributed to ongoing trade disputes and retaliatory measures. No doubt this is part of the frustration for Trump and the rest of the US political leadership as the tariff war rages on with China.

The Chinese share of global manufacturing has risen from about 5% in 1980 to almost 30% today. That far surpasses the United States, the #2 global manufacturer, whose share has declined to about 17%. The bigger China becomes, the bigger the global trade imbalances become, and that eventually leads to a typically difficult recalibration of the trading relationship, which brings us to the situation today.

We are significantly less concerned about trading relationships with U.S. Allies. Although harsh words have been spoken on both sides, we are confident that those relationships can be repaired. A thick skin is required to be in politics, and once a deal is struck, cooler heads will prevail.

China is where the trading relationship is more difficult to repair. The U.S. and China are global competitors, but they are also global adversaries, and that eliminates the ability to smooth things over. This is an economic war, and the U.S. hegemony is on the line. The outcome of this war will have long-term, far-reaching impacts on the global community, but we will limit our comments to financial markets.

The U.S. strength in this trading relationship is based on the power of the U.S. consumer. Without the U.S. consumer as a customer, China has a sizable excess of manufacturing capacity. If the U.S. stops buying, China would suffer from growing unemployment and potentially social unrest.

The China strength is the dominant position in manufacturing. COVID was a harsh lesson on just how vulnerable our supply chains were (are?) for basic, but very necessary, items like syringes and pharmaceuticals. If the Chinese stop shipping to the U.S., the U.S. would likely experience shortages and much higher prices for some goods, sparking social unrest here.

Getting down to brass tacks, neither picture is very pretty. The outcome would appear to be dependent on which country can outlast the other. Without a deal, it is a binary outcome. Either very positive or very negative for U.S. financial markets. The middle ground appears to require a deal being struck before each countries’ position can be fully tested. China’s small olive branch gesture suggests we may be able to find a middle ground, which is better for both parties and the rest of the world, but that is far from assured.

From our perspective, this implies that a focus on risk management remains paramount until the situation becomes clear. While the tariff battle ensues, we are close to a point where we are willing to selectively buy some high-quality companies that have been hit hard, but we will certainly not be going ‘all in’. We will take our time and proceeding cautiously.

Stay tuned and have a Happy Easter!!

 

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The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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By: Adam