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Navigating heightened volatilities amid threats to global trade

Escalating trade disputes have kept markets on edge.

"Trade imbalances are not inherently good or bad per se, and there is no straightforward relationship between trade imbalances and the state of the economy and the labour market. They are just a reflection that the Americans are consuming more than it produces." - Alice Tan.

A FULL-BLOWN trade war between the US and its key trading partners is likely to disrupt the global supply chain and impact trading volumes, with far-reaching repercussions for investors and businesses who need to exercise caution as they tread on the murky waters of trade spats.

Given rising volatility and uncertainties clouding over global trade, a careful and selective investment approach is increasingly important for private wealth clients.

Looking back on history, the last full-blown trade war in the 1930s was a global disaster and if history is anything to go by, China's President Xi Jinping has rightfully pointed out that "nobody wins in a trade war".

In 1930, the US administration enacted the Smoot-Hawley Tariff under Republican President Herbert Hoover, and raised the import duties on 890 products by an average of 40 per cent, to protect the US farmers and businesses.

The action prompted retaliation from foreign governments and a global trade war ensued. Many economists blamed the Act for precipitating the Great Depression.

The economic downturn that began in the US dragged the world economy down, and it was not until the mid-1930s that economies started to recover. From 1929 to 1934, world trade plunged by some 66 per cent. In the US, farmers suffered a big reduction in export sales and many defaulted on their loans. US unemployment rate jumped from 3.2 per cent in 1929 to 25 per cent in 1933.

US President Donald Trump is bent on pursuing an aggressive approach to trade, arguing that it would create jobs and strengthen national security. Protectionist measures have been implemented and announced.

In January 2018, the Trump administration imposed a 30 per cent tariff on imports of solar cells and modules, and a 20 per cent tariff on imported washing machines. It was a relatively "easy win" then for Mr Trump as foreign appliance manufacturers such as Samsung and LG quickly responded by announcing plans to open new factories in the US, helping to create jobs for Americans.

Emboldened and encouraged by the easy win on solar panels and washing machines, tariffs on steel and aluminium imports were quickly announced, followed by a list of imported goods from China. Cars and car parts from Europe are now the next target of the "America first" trade agenda.

Trade deficits: Good or Bad?

Combining goods and services, the overall trade deficit in the US amounted to US$568 billion in 2017. The largest bilateral trade imbalance is with China, with the country accounting for 66 per cent of the total deficit at US$ 375 billion.

Trade imbalances are not inherently good or bad per se, and there is no straightforward relationship between trade imbalances and the state of the economy and the labour market. They are just a reflection that the Americans are consuming more than it produces.

Will manufacturing jobs return to the US if trade imbalances are reduced? This may not be the case as the US today no longer possesses the comparative advantage in producing these goods.

Trade imbalances are caused by macroeconomic factors such as the relative growth rate of economies, a country's savings and investment rate, as well as the value of currencies.

What does the rest of the world do with the dollars earned from selling goods to the Americans?

For example, when China sells US$1 million worth of goods to the US, the country would have earned US$1 million in income. In the last couple of decades, in order to avoid a strong yuan, China has reinvested the dollar earnings in US assets such as US treasuries, equities and various types of real estate properties.

Mr Trump's protectionist stance could also pose threats to the US dollar, the world's dominant reserve currency. If the protectionist measures are implemented by blocking imports, the rest of the world may reduce their demand for US financial assets, resulting in higher US bond yields and weaker demand for US dollars.

The biggest risk for the dollar is the possible exodus of capital flows, especially at a time when the US needs to borrow from overseas to finance its current and budget deficits, which are rising towards 3 per cent and 4 per cent of the country's GDP, respectively.

Escalating trade disputes have engendered a general risk-off sentiment and kept markets on edge over the past few months.

So far, the economic damage is limited as the proposed and implemented tariffs represent only a small portion of global trade and global GDP. But the conclusion of the G7 Summit in June 2018 suggested that trade issues between the US and its key trading partners would not be resolved anytime soon, at least not till the US midterm elections in November.

While our base case is that the US and its trading partners will eventually reach a deal and avert a full-blown trade war, the prolonged trade uncertainty could affect business confidence and outlook on hiring and investment plans, creating downside risks to the economy.

We expect global equities to be supported by solid corporate earnings and equity valuations that are more reasonable, but market returns are likely to be more limited for the rest of the year against the backdrop of rising volatility. Thus, we have a neutral allocation to global equities and assign an underweight rating to bonds in the current rising interest rate environment.

  • The writer is Maybank Singapore's head of Private Wealth and Products and Investment Solutions

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