Investment Strategy & Market Update – April 2018
Markets started the year off in positive territory, rising over 6% during the first three weeks of January 2018. Optimism surrounding tax cuts and solid corporate earnings growth fueled stock prices higher. It appeared as if the abnormally steady year of 2017 would continue right into 2018, however various policy decisions along with the corresponding headlines has led to volatility since late January.

Tariff Tantrum
The Trump administration has initiated a series of aggressive tariff policies causing uncertainty in the investment markets. The idea of a prolonged trade war between the U.S. and its trading partners would be detrimental to the current economic momentum. We tend to believe there are no real “winners” in a trade war. History shows more often than not both sides of a trade war come out the other side with a weaker economic picture. Thankfully, it is our opinion that the worst case trade war is unlikely to be realized.

Let us analyze the first large tariff announced this March on imported aluminum and steel. The announcement seemed to come out of the blue and caught markets by surprise. We are now one month past the announcement and already exceptions to the tariff have been given to our most important trading partners in aluminum and steel like Canada, Mexico and the European Union. The exception allows for a “satisfactory alternative” to be negotiated over the coming months.

More recently President Trump has announced a total of $150 billion in new tariffs on China, followed by $50 billion in retaliatory tariffs placed on U.S. goods by China so far. Since 20% of Chinese exports end up in America, some believe we have the upper hand in this particular battle. China imports roughly 4 times the goods and services to the U.S. than are exported from America to China. In some ways this imbalance has been in the works for many years without effective pushback from policy makers in America.

Since China is a communist state with trillions in currency reserves, the government can more easily protect its citizens from harm by subsidizing the higher prices caused by new tariffs. In this way the U.S. is at a disadvantage versus the Chinese. More than anything, the communist People’s Republic of China craves social order. We believe by “stirring the pot” President Trump can get policy makers in China to the negotiating table much quicker than conventional means. It is an unconventional strategy which at times seems random and miscalculated, however a strategy that might just work given the circumstances.

If our fears are realized, and we participate in a tit-for-tat tariff war with China, we should expect higher than forecasted consumer prices. While the short-term reduction in economic activity that would result from a large-scale tariff war would be negative, it is the impact on prices which is the greater danger in our opinion. Quickly rising prices would necessitate a more active Federal Reserve. Additional rate hikes above what is already forecasted would entail a reevaluation of our economic assumptions for the next several years, and quite possibly a sizable adjustment to the stock and bond holdings for our clients. Quickly rising rates can create a difficult environment for investors with many unforeseen casualties. We believe this scenario is not probable, but the likelihood has risen since the tariffs have been announced.

As always, we are watching the ongoing development of the “tariff tantrum” and will adjust your portfolio should circumstances necessitate. Moving forward in this type of environment demands flexibility, patience and objectivity. We are so thankful for the opportunity to serve you, and are honored to have your trust in our team and in our process.

Regards,

Doug Blanton, CFA®
Chief Investment Officer, Merit Financial Advisors

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