May 28, 2019 Update on Global Trade

Global trade tensions have been elevated since early 2018. Much of the focus has centered on a tit-for-tat exchange of retaliatory tariffs between the U.S. and China, but trade restrictions with North American and European allies are also a factor.

The trade tension between China and the U.S. is bigger than just trade, which makes it more difficult to reach a quick deal. When we look at policy moves from China in the last decade, one thing becomes clear: China wants a seat at the table with the U.S. in world affairs. Naturally, the U.S. wants to keep its leadership role.

The escalated tension created both investor and business uncertainty and increased the potential for a mistake. The tariffs haven’t had a significant impact on economic indicators. Ultimately, we believe it is in the best interest of both parties that a long-term agreement will be reached. Investors should expect markets to rise and fall in the meantime in response to trade-related pronouncements from Washington and Beijing.

How we got here

As China’s influence around the world has increased, U.S. concerns about China have grown. Some have accused China of not playing by the rules.  President Trump argued that China is violating intellectual property rights by forcing foreign companies to engage in joint ventures with Chinese companies to give the Chinese companies access and permission to use, improve, copy and steal their technologies.

In 2018 the U.S. imposed tariffs on $250 billion worth of Chinese goods and China retaliated with tariffs on $110 billion worth of U.S. goods. Just recently, talks broke down and the U.S. increased tariffs from 10% to 25% on $200 billion worth of Chinese imports. China retaliated by raising the tariffs by 15% on $60 billion of U.S. goods (see chart at right)[1].

The U.S. is also concerned that Chinese telecom company Huawei Technologies could pose a security risk and may be used as a backdoor for spying by the Chinese government. Trump added Huawei to a trade blacklist, which prevents the company from buying parts and components from American companies without U.S. government approval

 

Market Effect

Tariffs are a tax on imported goods and are paid directly by U.S. importers of Chinese goods. The tariffs are paid to the U.S. Customs & Border Protection Service at the U.S. border. They are not paid by the Chinese to the U.S. Most economists argue that tariffs reduce economic activity by raising prices for consumers. However, the tariffs thus far have not been large enough to have a significant effect on economic growth. They also haven’t been large enough to move inflation higher.

 

The tariffs in place so far represent only about .3% of U.S. GDP. Even if all the threatened tariffs were to be imposed, it would still only represent about 1.2% to U.S. GDP (see chart).

 

The tariffs have affected world volumes however. We’ve seen a meaningful decrease over the last year[2] but still not significant enough to have us worried.

A long-term tariff increase could hurt American businesses with significant parts of their supply chains, consumer bases and other business dealings in China.

We’ve seen some signs of this already. During Q1 2019, S&P 500 companies with over half their sales coming domestically enjoyed earnings growth, on average, of 6.2%. Meanwhile, those companies with over half their sales coming from international sources saw their earnings decline by 12.8%[3]. We believe businesses will eventually adjust but in the short-term earnings could be further hurt. So far U.S. stock prices have been volatile but resilient. As of May 23rd, 2019, the S&P 500 TR Index is about 5% off its all-time high reached earlier in May.

The impact on non-U.S. stock prices been more significant. The Chinese stock market has underperformed the S&P 500 TR Index since the tariffs were announced last year[4].

 

In March 2009, China represented 12% of the MSCI Emerging Markets Index. Fast forward 10 years, and that has increased to 33%. China’s underperformance has had a significant impact on the MSCI Emerging Market Index[5].

While the ongoing trade tension has hurt emerging market stocks, we believe much of the risk has already been priced in. You can see that in the valuation difference between U.S. and non-U.S. stocks[6]. In our judgement, this could be an opportunity to buy Emerging Market stocks at lower valuations.

 

Summary

 

It has been a protracted and complex negotiation with China. There are certainly risks that things could get worse, but ultimately, we believe a resolution is likely. The impact so far has been felt mostly in emerging market equity prices and less so in U.S. stock prices and U.S. economic data. Continued market volatility seems likely until there’s some sort of resolution. The U.S. and China are tied at the hip when it comes to international trade and it’s in everyone’s best interests to resolve this dispute.

 

 

 

 

 

 

IMPORTANT DISCLOSURES

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy. The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors. For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

INDEX DEFINITIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.

The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.

China A-shares represented by the MSCI China A Onshore Index, a benchmark of Chinese equities largely traded by Chinese retail investors.

 

[1] Charles Schwab

[2] Bloomberg, Charles Schwab

[3] FactSet

[4] Capital Group

[5] Data from Morningstar

[6] Source: StarCapital. The presented valuation ratios are market-capitalization-weighted. “Weight” provides the actual country weight. PE (Price-Earnings-Ratio), PC (Price-Cashflow-Ratio), PS (Price-Sales-Ratio) and DY (Dividend-Yield) are based on trailing 12 month values. PB (Price-Book-Ratio) is based on the most recent company financial statements.

 

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Important Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.