Sizing Up the Latest Trade Talk and Choppy Stocks

Global markets tumbled Monday as investors grappled with the latest trade-related rumblings out of Washington. President Trump’s threat to slap a 20% tariff on auto exports from Europe to the US seemingly rattled folks on both sides of the Atlantic, and his administration’s reputed (and disputed) preview of forthcoming restrictions on Chinese investment in US companies added an extra layer of anxiety for US investors. Scary as some of this might sound, however, we still believe the renewed volatility looks typical of a correction—a sentiment-driven pullback, typically -10% or greater, that begins and ends without warning—and not a bear market. Trade worries are right in line with the morphing fear we have seen since stocks’ last hit a new high in January, and the fundamental backdrop hasn’t materially deteriorated. We believe this is still a time to be patient and remember markets can turn down—and up—for any or no reason, often when folks least expect it.

We realize it probably sounds weird and a bit Pollyanna to say economic and political fundamentals haven’t changed markedly for the worse in the past five months. After all, that was before the Trump administration applied, threatened or tweeted about tariffs on nearly $500 billion worth of US imports—and before trading partners threatened to respond in kind. Yet as one of our Research Analysts, Luke Puetz, explained on Friday, this still amounts to just 2.5% of US GDP being subject to tariffs. The tariff payments themselves would likely add up to less than half a percent of GDP, depending on what any eventual auto tariffs would look like.

Plus, it isn’t certain that all of these threatened tariffs will take effect—or that any of them would last indefinitely if enacted. After all, this is a midterm election year, and President Trump has long seemed to view tariffs as a way to rally the Republican Party’s base in the heartland. After November’s contest, it is entirely possible that the administration could moderate. Even if that doesn’t happen, many of the threatened tariffs target replaceable goods—things America can import from nations where tariffs don’t apply instead. In that case, the economic cost would be the difference between the current and replacement price, which would probably be smaller than the tariff payment. For instance, if Trump does adopt that tariff on European cars, a German automaker whose name rhymes with Tree Hem Bubblecue could reroute production so that its South Carolina plant focuses on the US market while international plants focus on exports.

As for the restrictions on investment from China, few outside the administration can even be sure what is real here. The source is the seemingly omnipresent “sources familiar with the matter.” But Treasury Secretary Steven Mnuchin denied the measures target China, too, dubbing the leaks “fake news” mere minutes after the release. Whichever is true, the issue here isn’t the much-maligned trade deficit, but worries about intellectual property protection. Under an initiative called “Made in China 2025,” Chinese leaders are racing to make China a leading producer of semiconductors, robots and other high-tech goods within seven years. To do so, according to myriad reports, they have relied on “purchasing” the necessary know-how by buying foreign firms with key patents and product lines (accusations of outright theft also abound). Blocking acquisitions aims to put a stop to this.

While we generally view any moves to disrupt the free flow of capital as negatives, we think it is important to consider the recent historical context. The US government hasn’t exactly approved a rush of Chinese takeovers in recent years. Prior administrations blocked several attempted mergers. Perhaps most famously, the Obama administration blocked a Chinese takeover of Micron, a chipmaker from Idaho. Earlier this year, the US blocked a Chinese takeover of Lattice Semiconductor. It even blocked the takeover of a tiny semiconductor firm by a German outfit. Seems to us that any potential “official” restrictions would merely formalize what the government has already been doing, in practice, for years.

The export controls are more of a change, and they could impact some firms’ earnings if the scope is large enough. But right now, all we have is a rumor, and any resulting policy wouldn’t take effect immediately. There would be a public comment period, during which the affected firms would get a chance to offer their opinion—both on how the policy would affect their competitiveness and whether it would at all address the problem the government aims to solve. In other words, investors should have time to think critically about any potential changes and take a more measured approach. We believe this is a much wiser course of action than reacting to volatility spurred by a single, detail-free whisper.

Overall, today’s environment still looks very correction-like. Five months may seem long for a correction, but it isn’t unusual. The correction before this one, which ran from late May 2015 to mid-February 2016, was nearly nine months long. 2011’s first correction lasted about five months. Sentiment during these five months also appears typical of a correction. As volatility escalated, investors grasped for causes to explain it, settling first on inflation. When that proved false, they flipped to fearing tariffs. This looks like another iteration of that fear-morph.

Meanwhile, economic fundamentals still look healthy. The global yield curve is only a smidge flatter than it was a year ago. Bank lending is still growing at a fine clip globally and has even accelerated in the US this year. Businesses are seemingly having no trouble getting the capital needed to invest and expand. Purchasing Managers’ Index surveys in America and Europe still signal growth in output and new business. Meanwhile, on the political front, gridlock persists throughout the developed world. Most European nations have hung parliaments with weak coalitions or minority governments. All seem preoccupied with the flagship sociological issue du jour, migration, and as a result aren’t pursuing sweeping domestic legislation. Therefore businesses don’t have to worry about property rights and regulations changing suddenly and making long-term planning untenable. The benefits of this calm should offset any small disruptions caused by bilateral tariffs.

Always keep this in mind: Markets are forward-looking. They are generally very good at discounting all widely known information. Has any economic issue been discussed more than tariffs over the last year and a half? President Trump has been talking about them since the 2016 campaign. China and intellectual property protections have regularly been part of the conversation since last year. Very little of what happened Monday and last week was actually a surprise to anyone. Or to markets.

Though it borders on cliché at this point, consider a proverb widely attributed to Ben Graham: In the short term, markets are voting machines; in the long term, they are weighing machines. Sharp swings like Monday’s are the market’s way of reporting all the punches in that voting machine. But in the long run, these moves even out, leaving a jagged trajectory in a larger general direction. With economic fundamentals still strong and trade protections still unlikely to become sweeping enough to derail commerce globally, we believe this correction will eventually look like a brief zig in a longer-term, upward zag.