The S%P 500 fell 3% yesterday and is off 5% from the highs over trade war fears.
My prediction for these latest round of tariffs (five and counting) is that nothing will happen. There will be no meaningful uptick in inflation as measured by CPI. The market has done this many times since Jan 2018 and has recovered each time in a v-shaped pattern, making new highs within 1-5 months. The fed is cutting rates into an economic expansion. This is unprecedented and extremely bullish. As shown below, the last time the fed cut rates into an expansion was in 1995, and the S&P 500 tripled from 500 to 1500. All these threats and tariffs against China have not hurt US GDP or corporate profits at all.
Regarding tariffs and trade, people are getting all worked up about something that will likely amount to nothing. A useful heuristic I have found is, if people cannot articulate the problem or policy, then it’s probably not a big deal. I remember asking a Trump supporter about her opinion of the tariffs and she said they are good because “China is cheating and not playing fair.” I then followed up by asking how so. Total silence. She could not articulate how China is cheating or even how tariffs work or what they do. This is not a dumb person, but it just goes to show how people hold strong opinions about issues that they know little about beyond the headline and soundbites such as “cheating” and “unfair”. In all fairness, I didn’t know much about it either until I googled it and spent some time reading about the issue. Most people don’t even bother doing to most basic of research before forming opinions about stuff.
The common argument is that China is manipulating their currency by keeping it artificially inflated, but what are the implications of this? It’s not obvious. Furthermore, if China is supposed to be artificially propping up their currency, they sure aren’t doing a good job at it, as the Yuan has lost 20% of its value relative to the US dollar since 2005.
The ball is in China’s court and they can make things worse for Trump in time for 2020 by retaliating, and this may force Trump to abandon his plans or dig in deeper. It may be rational for China to suffer some temporary pain if it means the stock market tanks and Trump loses. However I don’t see this scenario unfolding.
The upside of these tariffs is they give the fed further justification to cut rates. This is why the market will recover and make new highs soon, and I think Trump knows this. Trump is willing to to sacrifice some short-term stability for long-term gains. Trump knows that these tariffs are not hurting the US economy in terms of the labor market, profits and earnings, GDP, exports, etc. Low interest rates is just icing on the cake, and it helps boost support among his base by signalling being ‘tough on China’ even though far fewer people can explain what exactly China is doing wrong or what the implications are.