I agree with Fed Chairman Jerome Powell that it's too early to start talking about the consequences of a trade war that could take any shape from here on out. That would be the case in any trade war, but this one brewing with China presents particularly tricky forecasting challenges.
The reason is that China runs an enormous trade surplus with the United States, as referenced by President Trump in the following tweet last week: "We are not in a trade war with China, that war was lost many years ago by the foolish, or incompetent, people who represented the US. Now we have a trade deficit of $500B a year, with intellectual property theft of another $300B. We cannot let this continue!" In a separate tweet, he added: "When you're already $500B DOWN, you can't lose!"
In a trade war, the side with the deficit has a strategic advantage because it imports more from the rival. America imports so much more than China that there's far more room for America to maneuver by adding Chinese goods to its growing list of tariffed items.
Does this mean China would automatically lose a trade war with the US? No, and here's where it gets tricky. Because China would run out of products to counter-tariff, it would probably employ other ways of fighting back in a protracted trade war with the United States.
The first area most people like to go to when guessing what China would do is the bond market. Everybody knows by now that China holds billions of dollars worth of US Treasuries and is a major supporter of America's runaway spending problem. The argument goes that if China doesn't keep buying American Treasuries then the US will go bankrupt.
This is highly unlikely, in my view. It's too big.
The trade war issue is so far a small potatoes affair, and it should be mentioned widely and loudly that it hasn't even happened yet and probably never will. To respond to a list of goods facing a threat of temporary duties with a debt market catastrophe would be like the kitchen staff on a ship protesting pay cuts by capsizing the vessel. Cratering US Treasuries would kill the value of China's sizable Treasury portfolio. This path is too much too soon, and going straight to it as a danger we must avoid reveals irresponsible, lazy thinking.
The more likely response by China once its matching tariff list runs dry would be making life harder for American companies doing business in China, and the obvious one that comes to mind is Apple. If China cracked down on Apple facilities and the supply chain that supports them, crimping the business of one of the world's largest corporations, Washington would feel the heat in a hurry.
However, this would be risky on China's part because Apple might just up and leave. Given the increasing use of automation in manufacturing, there's been plenty of talk about not just designing devices in Cupertino, California, but building them there, too.
Quietly, behind the scenes, China is scared stiff at the rise of automation because it knows the technology could end-run the country's scale advantages before it ever moves up the food chain to innovation instead of just serving as the world's factory floor. If the likes of Apple (NASDAQ:AAPL) up and leave, China would lose the cachet of being where all the goodies are put together, plus the chance to learn (and steal, it must be said) from the best in business.
Going too far down this path is almost riskier to China than killing the value of its Treasury portfolio, because it would advertise that China is a lousy place to do business, and best avoided. At the top of China's ambitions is to control Asia. It's why it keeps stealing little pieces of other countries, expanding its footprint with minimal ripples. If a wholesale move from China to China's rivals around Asia were to occur, it would greatly set back Beijing's plans for becoming the undisputed crown of Asia.
If things went far enough, and everything played out through political channels, it's conceivable that America would put an additional thumb in China's eye by brokering a smooth transition of major US multinational operations from China to Taiwan, which China considers a breakaway province but which is officially a US ally. This would cement Taiwan under America's protective umbrella and directly transfer a chunk of China's GDP to the island it wants back, tarnishing Beijing's clout.
I've lived in Japan for nearly sixteen years, and have spent much of that time traveling extensively around Asia and meeting business people in Tokyo. I'm in Vietnam as I write this article. I've been in and around China a lot, and seen how it operates.
Based on what I've observed of China's behavior around Asia, I'm guessing it's going to proceed through the trade war the way it always proceeds, along blurry lines that make conflict unclear.
It never takes islands that matter, for instance, only little ones that nobody's sure are worth fighting over. Similarly, it would not push out Apple or General Motors (NYSE:GM). It would up the frequency of safety inspections, or add new shipping requirements, or create a new fee and a previously unheard-of accounting rule. This would be done and delivered with the message, "If you could help convince Washington to let up on the tariffs, maybe we could work something out for you." That's how China operates.
Therefore this trade war, such as it is, probably presents little risk of protracted stock market impact. Even if it actually happens, it won't happen in an explosive way, but in a nibbling, aggravating, slightly affected quarterly results kind of way over a long enough period for pundit commentators to grow bored with the issue and move on to more immediate fears to distract investors from long-term plans. They're nothing if not mesmerized by "BREAKING NEWS!"
My Sig system doesn't care whether there's an extended stock market impact or not. It'll react appropriately either way, and I'm actually hoping for lower prices over a couple of quarters to issue useful buy signals.
I provide this perspective merely to counterbalance the prevailing narrative this weekend, which holds that an impending trade war is imperiling stock market profits. It's probably not.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: My Sig system is always invested in US stock and bond index funds. My portfolio allocation this weekend is 77% stocks and 23% bonds.