Do not fear a trade war (part 1) - Josef Portelli

It is not at all surprising that US President Donald Trump is enacting policies that restrict free trade. Photo: Reuters

It is not at all surprising that US President Donald Trump is enacting policies that restrict free trade. Photo: Reuters

Anyone following the international news could not have missed the fact that frictionless trade between the world’s major economic powers and access to one another’s domestic markets are under attack. The use of the phrase ‘trade war’ is on the rise.

During the 2016 US presidential campaign Republican candidate Donald Trump criticised multilateral trade agreements like the North America Free Trade Agreement (Nafta) and the Trans Pacific Partnership (TPP). Soon after he became President Trump pulled the US out of the TPP negotiations and promised to renegotiate the terms under which his country joined Nafta.

Matters started to heat up this year when in January the US imposed tariffs on imported washing machines and solar panels. Then in June the Trump administration imposed tariffs on imported steel and aluminium. Exporters from the EU and neighbouring Canada were not spared. Canada and the EU retaliated with selected targeted tariffs on imports from the US. This month Trump announced further tariffs affecting $34 billion of Chinese imports with China hitting back with tariffs on goods imported from the US. According to CNBC, Trump threatened to place tariffs on all $505 billion of imports from China.

That President Trump is enacting policies that restrict free trade should not be a surprise. The genesis of the current row could be traced back to the 2008 global financial crisis. Balance sheets recessions tend to be followed by a rise in protectionism. Moreover, as we approach the 2018 November mid-term elections in the US the noise and action are likely to increase. According to the Pew Research Centre, more Americans view trade tariffs as negative than positive (49 per cent to 40 per cent with the rest undecided). However, among the Republican base a whopping 73 per cent view import tariffs positively.

As we approach the 2018 November mid-term elections in the US the noise and action are likely to increase

What is disconcerting about the developments described above is the fact that, at some point, the economic impact is going to be felt. That we live in a hyper connected world might sound like a cliché but is definitely true. Most of the products that we use on a daily basis are not produced in one single location. Rather, multinational companies have designed and developed complex global supply chains with goods being produced in multiple locations, sometimes moving back and forth several times before the product is ready for consumption.

Trade barriers make modern manufacturing more burdensome, hurting economic growth. Industry is likely to defer investment in capital goods when the outlook on where that manufacturing capacity is needed is unclear.

Naturally, financial assets will not ignore these developments. However, the impact will not be felt equally across all types of investments. Companies or countries that are dependent on exporting to the US the very things that Trump has targeted or has vowed to target, are at heightened risk of being impacted negatively.

If the trade war intensifies, equities issued by export-oriented companies are likely to remain under some pressure whereas safe haven assets such as bonds issued by developed countries, the US in particular, will be expected to find support. By extension, commodities such as industrial metals are likely to underperform gold. The performance of the US dollar is hard to predict. On the one hand, we have a President who wants a lower and more competitive currency in order to help domestic exporters, and on the other hand, the US dollar remains the world’s most used currency, providing plenty of demand in times of rising economic uncertainty.

The performance of currencies issued by emerging countries will depend on a host of factors such as whether the country is being specifically targeted by Trump, the level of export dependency and the amount of foreign currency reserves, among others. As the second most important currency, the performance of the euro will very likely be the inverse of what the US dollar does.

In such sensitive times investing becomes a matter of being selective and discriminatory making experienced active management a necessary condition for good investment results. Gone are the days when the price of everything goes up in tandem. This holds especially true when major central banks are gradually tightening monetary policy. But to paraphrase John F. Kennedy, a crisis creates opportunities, or in our case, market turbulence creates very good entry points, thus delivering superior investment returns over the medium to long term.

Josef Portelli is head of Investment Management at APS Bank Limited. Prior to joining APS he managed money in London for 13 years.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. APS Bank Limited is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

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