Trade 'Dispute' Not Trade 'War' - Q2 2018 Market Commentary


  • The 2nd quarter of 2018 saw global equity markets lose some ground from the first quarter, much of it attributed to the growing trade war dispute that is taking shape.
  • In June, MSCI All-Country World Index lost 0.54% but still ended the quarter with a slight gain of 0.53%, much of the gains coming from the U.S. market.
  • Oil prices rallied due to supply concerns stemming from Libya and Iran as well as major oil producers, Saudi Arabia and Russia, agreeing to raise production less than expected.
  • Of the worldwide tariffs announced so far between the U.S. and her trading partners, the Tax Foundation estimates that long-term U.S. GDP would decline 0.44% along with negative impact on wages and employment.
  • Is the Trump ‘trade dispute’ enough to push key macro and market risk indicators into deflationary territory?  We may get a glimpse over the summer, but investors should keep an eye on the term structure and credit spreads.

2nd Quarter 2018 Market Commentary And 2nd Half Market Outlook

Data Source: Bloomberg

‘Trade Dispute’ Not ‘Trade War’


Note to readers: We have sectioned the 2nd Quarter 2018 Market Commentary and 2nd Half Market Outlook commentary accordingly:

June 2018/2nd Quarter Highlights 2nd Half 2018 Outlook Supplemental charts and exhibits

‘Trade Disputes’ Drives Narrative For Explaining 2nd Quarter Market Volatility

“U.S. is not in [a] trade war with China, it is a trade dispute.” – Treasury Secretary Steve Mnuchin on Fox Business, 6/29/2018

The 2nd quarter of 2018 saw global equity markets sell off, much of it attributed to the growing trade war dispute that is taking shape between the U.S. and the rest of the world. Based on regional equity market and currency performance, the U.S. appears to come out on top of the trade dispute so far with the S&P 500 gaining 3.4% for the quarter versus 1.3% loss for MSCI Europe, 2.8% loss for MSCI Japan, and 8.0% loss for MSCI Emerging Markets. The trade-weighted dollar also gained 4.9% for the quarter and is now up 6.6% from its lows reached earlier in the year.

One can be forgiven for losing track of the tit-for-tat fury exchanged between world leaders as headlines seem to gravitate between retaliation and conciliation. The Tax Foundation is keeping track of all the announced tariffs and has produced a concise summary of the estimated worldwide trade tariffs that have been announced so far as well as their estimated impact on the world economies. The report encapsulates the Trump Administration’s message of ‘more pain for more gain’ approach to revisiting worldwide trading relationships. Some highlights from the report:

  • “The Trump administration has enacted tariffs on imported solar panels, washing machines, steel, aluminum, and various products imported from China. [Tax Foundation] estimate that these measures will apply to roughly $96 billion worth of imports, for a total tax increase of $21.6 billion.”
  • “According to the Tax Foundation model, the tariffs enacted so far by the Trump administration would reduce long-run GDP by 0.06% ($15 billion) and wages by 0.04 percent and eliminate 48,585 full-time equivalent jobs.”
  • “Several countries have announced plans to impose tariffs in response to the U.S. tariffs on steel and aluminum. The tariffs target American products such as denim, bourbon, whiskey, and agricultural commodities, for an estimated total tax of $16.93 billion. More countries are considering imposing retaliatory tariffs on the United States...”
  • “If these foreign jurisdictions enacted the tariffs that they announced, the Tax Foundation model estimates that U.S. GDP would fall another 0.05 percent ($12 billion) and cost an additional 37,590 full-time equivalent jobs.”
  • “If all tariffs announced thus far were fully enacted by the United States and foreign jurisdictions, U.S. GDP would fall by 0.44 percent ($110 billion) in the long run, effectively offsetting one-quarter of the long-run impact of the Tax Cuts and Jobs Act. Wages would fall by 0.31 percent and employment would fall by 341,459.”

Now granted, this report comes from an organization committed to freer trade, but it highlights a reasonable scenario of the long-term negative impact on economic output from higher trade tariffs. ‘Trade disputes’ are never pretty and they can, indeed, produce ‘short-term’ pain in the form of higher prices (via higher imputed taxes), lower economic output, and loss of jobs.

Yet, the full fall-out of the global ‘trade dispute’ has yet to unfold, and we should be cautious and not succumb to hyperbolic apoplexy of the kind exhibited by this economist (incidentally, I’m not sure if I want Paul Krugman to negotiate my next auto purchase). And underneath the surface of all the apoplexy, the Trump Administration may actually be scoring some trade ‘wins’ (the following list courtesy of Rich Farr, Merrion Capital, from a report published on 6/20/2018):

China renewed U.S. soy bean purchases in late May following a cut-off in April (in response to the initial tariff threats). China to cut tariffs on imported cars from 25% to 15% (in addition to cutting tariffs on imported car parts to a standardized 6% from a range of 6-25%). China has pledged to allow more foreign ownership of financial sector by year-end (note: this may not be such a good thing for overseas financials given the heavy leverage within China’s banking system – see our 1Q2018 Market Commentary). Europe has joined the U.S. in putting pressure on China’s intellectual property transfer policies. South Korea negotiated a new trade deal with the U.S. on auto imports and steel/aluminum exports. Germany may be backing the abolishment of auto tariffs into Germany as well as eliminating the European Union’s 10% tariff on imported cars.

Investors and much of the financial media are struggling with what to make of the gyrating headlines over trade disputes, European migrant disputes, and increasing exertion of U.S. exceptionalism (non-endorsement of the G-7 communique, bilateral discussions with North Korea and Russia, exerting pressure on the global banking system to enforce sanctions on Iran). This wrestling with the headlines versus the fundamentals can be summarized by these two contradictory statements, separated by just one week, from Randall W. Forbes, who writes the Up and Down Wall Street column for Barron’s:

“The real news of the week, from the markets’ perspective, was that mundane fundamentals of growth and monetary conditions count more than hyperventilating [trade dispute] headlines.” – Tariffs, Nukes, Rates: More Sound Than Fury (6/16/2018 edition)


“…it would not be an enormous stretch for investors to downgrade global growth expectations, due to fears about a trade war (citing Arjay Rajadhyaksha, Barclay’s Head of Macro Research)…However the trade and capital-flows disputes ultimately are resolved, they create uncertainty for Corporate America.” – Tariffs’ Toll on Trade (6/22/2018 edition)

The end of the 2nd quarter demonstrated the challenge in publishing weekly market commentary that has characterized the market environment for much of 2018.

The Challenge Of Shifting Narratives

3D is a frequent publisher of commentaries covering market-moving narratives, so we can sympathize with those struggling to stay keep abreast of the headlines. When we survey our own writings, we find ourselves occasionally whipsawed by the ‘narrative’ of the moment. For instance, earlier in the quarter, we commented on how investors were starting to abandon ‘momentum’ style of investing only for it to become one of the best performing factors as it advanced well ahead of all the major factors before tanking two weeks prior to the end of the second quarter ( Figure 1).

Figure 1 – Momentum Maintains Factor Leadership In 2Q But Underperforms Late In The Quarter

Low/minimum volatility strategies outperformed in the quarter following a late June rotation into defensive segments of the market. Investors turned sharply towards risk-off near the end of June as the sound volume surrounding trade ‘dispute’ rhetoric reached 11. Defensive sectors such as consumer staples and bond-proxy sectors such as utilities and real estate outperformed in June (Figure 2), which helped contribute to low volatility/minimum volatility factors’ outperformance versus the broader market (partially confirming, once again, the interest rate sensitivity of said factors).

On the losing end were cyclical industrials and financials, the latter of which are suffering as the spread between short and long-term interest rates continues to narrow. Another market theme (cyclical reflation) appears to be busted for now although the strong performance of oil and energy stocks is keeping this theme on life support.

Figure 2 – Defensive Sectors Lead In June While Cyclicals And Financials Lagged

Another puzzling disconnect is the positive performance of below investment grade (high yield) credit (Figure 3) relative to other fixed income sectors, a sign of increased risk appetite, versus a flattening Treasury yield curve (2-10 year term structure) and wider investment grade credit spreads (Figure 4), both signs of early deflationary concern.

Figure 3 – High Yield Credit Outperforms Broader Fixed Income Despite ‘Risk-Off’ Positioning

Figure 4 – A Flattening Term Structure And Wider Investment Grade Credit Spreads Point Towards Increased Deflationary Risks

Along with the sharp underperformance of emerging markets (Figure 5), one starts to draw a conflicting picture of the market environment. Emerging markets felt the brunt of the trade war rhetoric, although early 2nd quarter weakness could also be attributed to ‘local’ issues across Turkey, Argentina, South Africa, and Brazil.

Figure 5 – Emerging Markets Are The Worst Performing Region In June

Is the Fed About To ‘Strangle’ The Markets?

Much of this conflicting picture between risk-on cyclical reflation and risk-off deflationary concerns can be sourced to the Federal Reserve as they continue to embark upon their rate tightening campaign for the purposes of normalizing monetary policies and removing vestiges of the ‘Fed’ put (see our 1Q2018 and February 2018 Market Commentaries, where we, some would say ad nauseum, discuss this more in-depth).

In addition to the financial tightening that the rate hikes are starting to produce, the Fed’s reactionary function to market-disrupting events can be viewed more as a Fed ‘strangle’, rather than a Fed ‘put’. Credit goes to Stifel Financial macro strategist, Barry Bannister, for coining the ‘strangle’ concept which posits that the Fed has, theoretically, sold both a put and a call option but with much wider strike prices around current market levels versus what may have been observed with prior Fed regimes. Wider strike prices imply a lower probability of those put and call options from being exercised.

Under Fed Chairperson Jerome Powell, the imputed strike price on the Fed put is at a much lower level versus prior Fed regimes which were more sensitive to deflationary spirals brought on by the onset of volatile markets post the 2009 Great Recession.

In other words, the Powell Fed is less likely to step in to support the markets during a price swoon, and the sell-off would need to be much deeper to compel the Fed to react. In contrast, the high imputed strike price on the Fed call makes the call option less likely to be exercised as the Fed’s monetary policy seems to be more sensitive to market imbalances brought on by runaway asset prices or excessive risk-taking.

As long as the U.S. economy continues to grow at peak employment levels with inflationary threats just around the corner, the Powell Fed can maintain the policy strangle while pursuing a rate normalization schedule that brings short-term rates in line with the theoretical neutral real rate of interest. It will be interesting to see how the Powell Fed would react to a deflationary scare before the Fed Funds Rate reaches, and exceeds, the neutral rate of interest, expected sometime in mid-2019.

2nd Half Outlook

Diverging monetary policies between the U.S. (rate tightening) versus the rest of the world (Japan and Europe remain in quantitative easing mode) has caused concerns that the rest of the world will not be equipped to shoulder the higher interest rate burdens and reduced dollar liquidity from U.S. Fed tightening, especially for foreign borrowers that have issued dollar-denominated debt. Apart from trade disputes, the Fed remains the primary concern among investors as prior tightening regimes have ended with the U.S. in recession and the rest of the world suffering from the loss of liquidity.

The diverging performance between U.S. assets (equities, fixed income, currency) versus the rest of the world has produced a widening gap in relative valuations based on price / expected earnings over the next 12 months ( Figure 6).

Figure 6 – Forward P/Es: The Rest Of The World Is Starting To Look Cheap Versus The U.S.

However, the key to forward valuations is whether the ‘E’ or earnings can be stabilized; in the case of emerging markets, earnings estimates are starting to drop although they continue to grow in Europe and Japan.

As for commodities, the global supply/demand picture (Figure 7) has returned to balance after operating in a net deficit over the past year as the oil price rally has led to higher oil production. However, slightly lower demand has met increasing supply; trailing 12-month global demand dropped slightly in June although this was after a sharp increase over the prior 11 months. Commodity investors banking on further oil price rallies should be mindful of a potential tapering off in demand.

Figure 7: Global Oil Supply/Demand Differential More In Balance Following Oil Price Rally

Finally, U.S. fixed income is presenting a mixed picture of U.S. inflation and growth. The core component of the personal consumption expenditure (PCE) price index has reached 2% growth on a year-over-year basis which, along with the strong employment environment, giving the U.S. Fed ammunition to pursue rate tightening.

But, widening investment grade credit spreads and a flattening Treasury term structure suggest financial conditions have tightened to a point where the risk of a deflation has now emerged. If inflationary pressures have peaked, then investors may start gravitating back into long duration Treasuries and other safe-haven assets (i.e. the Japanese yen) as a hedge against market volatility.

Is the Trump ‘trade dispute’ enough to push key macro and market risk indicators into deflationary territory? We may get a glimpse over the summer, but investors should keep an eye on the term structure and credit spreads as early clues that the U.S. economy may slow down enough for the Powell Fed to hit the pause button on the rate hike schedule. The Fed may find itself in a bind if headline inflationary figures, driven by higher oil prices, remain elevated above the 2% comfort zone. This should make for an interesting summer.

3D Asset Management 2Q And Year-to-Date 2018: Charts And Exhibits

This document provides charts and exhibits covering market performance and macro economic conditions. All data comes from Bloomberg unless noted otherwise.

QTD Ending 6/30/2018

YTD Ending 6/30/2018

Other Key Charts

High Yield And Investment Grade Credit Spreads

Global Energy Supply And Demand

U.S. Domestic Drilling And Employment

2- Vs 10-Year Treasury Spread And 5-Yr/5-Yr Forward Inflation Expectations

Primary Global Sovereign 10-Year Yields

Industrial Metals and Oil

U.S. Dollar Spot Index and Against Euro And Yen

Global Equity Valuations (Price / 1-Yr Forward Earnings)

S&P Operating Margins and Rolling 1-Year Revenue Growth

Disclosure: The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate however 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete.

Past performance is no guarantee of future results. None of the services offered by 3D Asset Management are insured by the FDIC and the reader is reminded that all investments contain risk. The opinions offered above are as July 2, 2018 and are subject to change as influencing factors change.

More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm’s Form ADV Part 2 which is available upon request by calling (860) 291-1998, option 2 or emailing or visiting 3D’s website at

This article was written by

Benjamin M. Lavine, Co-Chief Investment Officer at 3D/L Capital Management, is an investment professional with 20 years of experience in asset management and institutional consulting. Ben brings a versatile investment background and knowledge set having served as a portfolio manager on the developed markets equity team at Batterymarch Financial Management and as a vice president in the Funds Management Division at Wilshire Associates. Ben brings expertise in the following areas: Global Quantitative Equity Research and Management, Macro Investment Strategy, Institutional Product Management and Development, and Institutional Consulting and Public Markets Fund-of-Funds Ben received his MBA from UCLA’s Anderson School of Management, holds the CFA designation, and has experience working on data platforms including Bloomberg, Factset, MATLAB, Orion Technologies, and Thomson/Reuters.

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.

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