The New Chinese Tariffs: Looking At The Numbers

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by: Burt Rothberg
Summary

JPMorgan thinks the effect on US GDP and inflation will be mild.

However, the effect on corporate profits will be substantially greater.

Industrials and technology will be hardest hit.

There has been a lot of talk about the recent Chinese tariff hikes, but until now, I haven't seen too many quantitative estimates. Here's what the researchers at JPMorgan (NYSE:JPM) and some others say.

There's little effect on overall US GDP. A recent Yale/Berkeley/Columbia paper estimates a net output loss in the US of just 0.04% of GDP from tariffs imposed in 2018. If we double that to account for the new 25% rate on Chinese goods, that is still a very small number. In fact, it's well within the accuracy of GDP measurement, so it may not even be registered in the statistics. However, this is an ongoing loss, not one-time.

There's also only a small boost to inflation. Here are some estimates, courtesy of JPM:

Forecast by Impact on 2019 Inflation Resulting From
JPMorgan 0.1% - 0.2% The recent 25% Chinese hike
Federal Reserve 0.4% A complete 25% Chinese tariff
Bridgewater 0.4% "Full escalation"
Goldman 0.6% A complete 25% Chinese tariff

Note that these are one-time numbers, not ongoing. So, it's not likely that the Fed will respond strongly to them. Also, they do not include second-order effects, such as companies shifting production to other low-wage countries. These effects would eventually make up for some of the extra inflation. Again, not much here.

The effect on corporate profits is larger. Corporate margins have been a main beneficiary of globalization. In fact, I think it's fair to say that globalization has been the main factor in margin expansion over the last generation. A group called Empirical Research Partners has calculated that the 2018 hikes alone were equal to 2% of S&P profits. You can double that with the events of last week. Again, this excludes second-order effects which would blunt it over time. JPM emphasizes that the effect could be much greater in industrials and tech, where the percentage of international revenues are much greater.

Personal aside: When I was studying economics fifty years ago, the major model of international trade was the Heckscher-Ohlin model. One of its theorems was that an increase in trade would benefit capitalists in developed countries and hurt workers' wages. That's pretty much how it turned out. Score one for economic models.

The effect on investor sentiment could be substantial. The new tariffs reverse tariff reduction since about 1990. If Trump follows through with a full Chinese tariff, it would bring us back to about 1970. If he then adds European autos as well, we go back to the end of WWII! During this time, large-cap multinationals have built their strategy on globalism. Whole economies have been built on exporting to the US. Many of the factories in China will become stranded assets and will have to be written down/off. This will lead to a continuing drip of bad news that would extend over a long period of time.

Most importantly, this comes at a time when overall valuations are rather high. So, the possibility of a downside is that much greater.

How you play this depends on you view of politics. Here's my view: Trump does not want a financial market crash and will be careful to avoid getting into waters that allow one. On the other hand, politicians are most interested in getting re-elected. The overall effect on GDP is small, and there is a widespread view that China is taking us for a ride. Note that before the talks broke down, the Democrats were gearing up for an attack on Trump for making a soft deal. This article gives some statistics on the US view of this. Worth a read.

So, I expect a seesaw market in which trade escalation is interspersed with periods of optimism and the realization that many companies will see little effect. This will be a market in a wide range for a while.

Disclosure: I am/we are long VTI-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.