As expected, volatility is on the rise, most recently fueled by bargaining tactics and a clash of egos that are threatening to provoke a trade war between the two largest economies in the world. Global markets were shaken by the news in March, as we see reflected in increased volatility and a drop in equity markets.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index
As has been largely covered in the news, the initial cause for concern was a threat of new tariffs on imported aluminum and steel into the US. The policy – which caused a rift in the White House and resulted in the resignation of the Chief Economic Advisor – goes against most economist’s values that free trade is better for all involved. This new wave of protectionism dismisses traditional economic thought, is widely unsupported by most businesses, and will see consumers in the US and China bearing the brunt of the hit.
Recent actions by the American government suggest that this may be a negotiating tactic to flex a muscle and invoke fear of what’s at stake, followed by compromises to achieve a more balanced solution. This is already evident in the fact that Canada and Mexico are exempt from these tariffs “so far”.
What’s more worrisome is the precedent being set that a country like the US can levy these tariffs by implying that it’s a national security threat. If more countries – such as China – apply this same logic, then the World Trade Organization’s courts will lose their power to enforce regulation, and a global authority who oversees trade will lose credibility.
A trade war is a threat, and it’s something we take seriously when monitoring portfolios. However, global markets are so integrated in 2018 that businesses are bound to be outspoken against these measures, since the impact hurts all parties involved. For this reason, we believe that cooler heads will prevail and right the ship. For example, the chart below shows how deeply integrated the supply chains are of the two countries.
In addition, when discounting the geopolitical issues at hand, the global economy looks quite healthy. Key economic indicators like employment and consumer confidence are still considerably positive. The manufacturing index – a key driver of GDP growth – continues to be strong globally, and suggests stronger than expected GDP growth (see image below).
The end game of protectionism is lose-lose for all parties involved. What you end up protecting against is growth, as stifled trade leads to higher prices and larger regulatory burdens. The world is far too connected now to let something like this impact business too significantly. When coupled with the solid fundamentals that still power the undercurrent of the global economy, this trend does not seem like it will keep up steam. Stay invested, we may see more opportunities to rebalance and take advantage of buy-low opportunities.