Financial pundits are generally up in arms about President Trump’s aggressive escalation of the trade conflict with China. According to the consensus of said pundits, escalating the economic conflict with China makes no logical sense: It hurts the US economy and it hurts the stock market. And it therefore hurts Trump’s re-election chances.
To comprehend why Trump is escalating the economic conflict with China, I believe that one must understand that his motivations are not primarily economic. His motivations are primarily political and personal. Indeed, to understand the Trump administration's policy toward China, I believe that you need to understand the following points, in order of importance:
1. Trade policy is being driven by electoral politics. Trump currently trails almost every single major Democrat in presidential polls in critical battleground rust-belt states, such as Michigan, Pennsylvania and Ohio. Trump trails Joe Biden by an average of 10 points, and is even trailing Bernie Sanders by an average of 6 points in these battleground states. There's no path to reelection for Trump that does not involve winning these three states. As a result of being far behind in the polls in these key battleground states, Trump feels that he needs to deliver something BIG to turn around his polling in these states. In this regard, I believe that Trump has concluded that an extremely aggressive “us vs. them" trade stance against China is essentially the only option available to him to salvage is reelection prospects. Trump is engaging in a high-stakes bet that a confrontational approach to trade with China will energize his base and will maximize turnout for him in rust-belt states.
2. Sudden shock gets maximum negotiating effect. Hitting China hard, and all at once, will have maximum negative effect on China's economy. Trump is betting that the Chinese will not have enough time to contain the damage domestically with fiscal and monetary policy. And they will not have time to diversify their customer base and supply chains. Trump believes that this negative shock on his Chinese adversaries will provide him with far more negotiating leverage than if he implements a “gradual” approach to escalation.
3. Get negative pain over with. Trump knows that delivering a trade shock to China will entail absorbing some degree of pain in the US. However, Trump has probably calculated that's better to hit the US economy all at once immediately than to spread out the damage over time. This will give the US economy time to adjust and recover before the November 2020 elections.
4. Precipitate fiscal and monetary stimulus. First, Trump knows that delivering a strong trade shock will spur the Fed to deliver significant monetary stimulus, in the form of rate cuts, and potentially even another round of QE. The Fed has made it publicly clear that it stands ready to deliver monetary easing to support the US economic expansion in the face of the "economic uncertainties" brought about by the US-China trade conflict. Second, trade shock measures will maximize Trump's chances of passing targeted fiscal stimulus in a bipartisan manner through Congress. Trump knows that there is no way that Democrats won’t vote for measures that support Midwestern manufacturers and farmers that are the hardest hit by the trade conflict.
5. This is personal. First of all, Trump relishes high-stakes gamesmanship in the context of negotiation. Second, Trump's personal legacy as a "master negotiator" is at stake. Third, although there are few things that Trump actually believes in from a policy standpoint, protectionist trade and industrial policy that support American manufacturers is something that Trump has been extremely passionate about and has spoken publicly about since he first burst onto the national scene in the 1980s. For Trump, his fight against China on behalf of US manufacturing is something he believes deeply. Indeed, I believe that Trump is convinced that this could become his greatest potential legacy as president.
How To Invest In A Market That's Driven By Politics
As a portfolio strategist, my job is not to agree or disagree with President Trump. It is my belief that one’s personal policy preferences can play absolutely no role in analyzing, designing and implementing investment strategy. My job as a professional portfolio strategist is to manage portfolios. Thus, in this context, the challenge which the current situation imposes upon me as a professional portfolio strategist is to understand President Trump’s manner of thought and action, perform appropriate scenario analysis, and position my investment portfolios accordingly. In Successful Portfolio Strategy, our portfolios have been positioned for the risk of an escalation of the trade conflict with China. And going forward, our portfolios will be very well positioned for the extremely interesting opportunities that are developing before our eyes. Indeed, we see the current bout of politically-driven volatility as a major investment opportunity in the making.
But for now, US equities most likely still have some downside action to work through before stabilization and resumption of an upward trajectory. Based on the greatly increased risks to global growth, US economic growth and US corporate earnings that have been brought about the US-China economic conflict (and concomitant global economic and financial risks), a 10%-plus correction from all-time highs is fundamentally warranted. In this context it can be helpful to look at how the US equity market stands from a big-picture technical analysis perspective:
The first important thing to note is that the S&P 500 (SPY) clearly collapsed through its initial short-term support region at around its “triple top” region above 2900. Second, please note that US equity market momentum, on an intermediate-term basis, is clearly “busted” as can be seen by analyzing the three-month ROC indicator. Third, please note that the market is currently in the process of testing a critical short-term support zone around 2800 to 2730. This is an area in which strong horizontal support lines converge with the one-year moving average (blue line) – an indicator which has very successfully served as a marker of the intermediate term trend in the past decade. In the context of this strong converging support region, it would be normal for the market to either bounce off of this support area or to make violent “sling-shot” moves below and then above it in the short-term. Indeed, the S&P 500 (SP500) held this region nicely overnight on Monday and during the Tuesday session. However, even though the 2800-2730 region constitutes a critical support level, and a "reaction" is to be expected around this zone, I do not ultimately expect this level to hold in the intermediate term.
Given the magnitude of negative fundamental events, I expect this support region to be broken, setting up a momentous technical test of the critical key intermediate-term support region which begins around 2600. Indeed, it's my view that from a technical perspective, the continuity of the current bull market will probably hinge on a successful test of this region.
If the above-mentioned critical test of intermediate-term support does, indeed, transpire, the team at Successful Portfolio Strategy will be ready to take the appropriate portfolio management steps in accordance with a combination of fundamental and technical conditions at that time. In particular, at that time, it will be critical to evaluate the strategic state of the US stock market cycle, an asset price cycle which tends to be primarily determined fundamentally by the prospective state of the US business cycle.
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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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.