Is Market Overreacting To Trade War Risk? March 28, 2018
In this article, we are going to discuss what are the possible scenarios and impacts should it happen in the near future.
Author : Jerry Lee Chee Yeong

Is Market Overreact To Trade War Risk?

US-China trade war has been widely discussed in recent days after Donald Trump signed the tariff order on up to $60 billion worth of Chinese imports which include items like aerospace, information and communication technology and machinery. In response, China announced tariffs on $3 billion worth of US imports and mentioned that they are not afraid of and will not recoil from a trade war. Immediately after the announcements from the two world economic giants, the escalating threat of a global trade war sent the global equity market sharply lower in choppy trading on last Friday. In this article, we are going to discuss what are the possible scenarios and impacts should it happen in the near future.

How Did Global Market React To Trade War Risk?

The global equity market saw renewed sell-off last Friday, with the Dow Jones Industrial Average Index and Nikkei 225 Index tumbling to the lowest level in 2018. On average, the Asian equity markets dropped about -1% to -4% in single trading day, reflecting the heightening trade war risk between US and China.

Figure 1: Market Performance after The Tariffs Announcement

What Exactly A Trade War?

In essence, trade war refers to a situation which involve two or more countries, whereby each of them is trying to damage or hurt the trade activity of the others by imposing tariffs or quota restrictions in order to increase the competitiveness of the local products. On top of that, trade war can also happen through limiting the foreign investment in the local economy. In fact, this is exactly what is happening between US and China.

In fact, the main reason that triggered Trump to propose and sign the tariff measures on China imports is the historically high trade imbalances between the two largest economy where Trump claimed that China is operating on an uneven playing field (at the expense of US). On top of that, China is also accused of intellectual property theft and forcing the US company to transfer their industry secret and technology to the country.

Although Trump has signed the tariff measures, it does not mean that the tariff will go into effect immediately. The US Treasury Department is given 15 days to finalize the list of products that are subjected to tariffs while the tariff will only go into effect after a 30-day consultation period that starts once the list is published. Hence, there is a chance that the tariffs can be averted between this period, provided that both US and China are able to reach a mutual agreement.

Is China The Biggest Loser?

Not China, but probably the US farmer, consumer and the US economy would take a harder hit if trade war were to happen. According to several research results, the 25% of tariffs on $60 billion of Chinese imports is likely to hit the China GDP growth rate only by about 0.1% to 0.15%. Hence, the impact is believed to be minimal to the second largest economy in the world.

However, not to mention if China were to retaliate, the US consumer is likely to emerged as the biggest loser in the US-China trade war. It is almost impossible for the US government to impose the tariff on Chinese imports without hurting the local consumer. A higher tariff means higher price to pay by the US consumer hence, although the tariffs is aimed at China, the additional cost will eventually be charged to the American consumer. As the local private consumption accounts for about 70% of US total GDP, the increasing living cost as a result of escalating tariff would hit the economic activity in US.

Apart from that, if China were to take a serious step to retaliate, they are likely to halve the imports of soybean from US while looking for replacement from the South America country such as Brazil and Argentina. Consequently, this is likely cause a significant impact to the local farmer as China, on average, imported close to 30% of the total soybean produced by US over the past 3 years. To make the matter worse, farmers are the major supporters of Trump, hence the pressure will eventually go back to Donald Trump.

Our View

To a certain extent, we believe that the recent decision to impose the tariffs on Chinese imports might be part of Trump’s political tactic for the coming mid-term election in November, as he previously vowed to combat the unfair trade and make America great again. Hence, it could just be a game of paper tigers by Trump with the intention to show his voters that he is willing to play the “hardball” in order to reduce the historically high trade deficit with China.

In addition, given that China is currently the largest holder of US sovereign debt (19% of US debt to foreign creditors), the outcome would be disastrous for US if China decides to dispose large amount of US debt as a retaliatory measure.

We believe it is likely that both US and China will eventually head back to the negotiating table given that both parties are likely to be hurt by the trade war, at least that’s what history has shown.Therefore, the recent sell-off might present a bargain hunting opportunity to investors.

However, as mentioned earlier on, we believe that the market volatility will be here to stay throughout the year, hence, we would like to advocate our investors to focus on the fundamental and stay invested in the market to prevent one from being affected by the emotion of fear and greed as market fluctuates.

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