Investment Newsletter March 2018
Winning the unwinnable “Trade wars are good and easy to win.” So said Donald Trump, President of the United States, shortly after announcing new trade tariffs on steel and aluminium made outside of the US (via Twitter of course).
Mike Deverell Investment Manager
Equilibrium Investment Management
Much of the rhetoric around Trump’s new policy does indeed mention China. China is the world’s biggest steel producer, accounting for around half of the world’s steelmaking capacity. However, in Chart One, we can see that China doesn’t feature in the top countries for steel import into the U. S.
Trade tariffs are nothing new and they apply on various goods. They are generally in place to protect jobs and industries where they are key to an economy. For example, if the US steel industry was vital to the US economy and employed millions of people, then cheap steel imports from (say) China could be a major threat. In that instance, large tariffs may well be justified and could potentially even be targeted against China specifically.
In fact, China only accounted for 2% of US steel imports in 2017. A combined 25% came from Canada and Mexico, both members of NAFTA (the North American Free Trade Area). Although Trump wants to renegotiate this agreement, for now this means that there will be no tariffs for these two countries (who also account for 42% of aluminium imports).
However, it is important to be careful about the use of such tariffs. Often they can have unintended consequences, let alone the increased likelihood of other countries responding in kind.
The big problem with Trump’s new policy is that the US doesn’t make that much of its own steel and the American steel industry employs relatively few people. The policy is great for those individuals who may now
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter March 2018
be more secure in their jobs and the industry may well employ more people. However, the same tariffs could actually hurt other industries, potentially affecting jobs elsewhere. In fact, according to research by The Trade Partnership (“Does Import Protection Save Jobs?”, March 5 2018), whilst the tariffs would increase employment in steel and aluminium related industries by around 33,000 jobs, this would be more than offset by a loss of around 179,000 jobs elsewhere. So why the job losses elsewhere? In essence, the US won’t be producing nearly enough domestic steel to meet demand and so it will still need to import it. That just means that it becomes more expensive. Industries which rely on steel to make other products will either need to absorb these higher costs, reducing their margins and impacting employment, or pass on higher prices to their customers. Neither option is great for the US economy.
EU threatened to respond by adding tariffs to popular American imports such as Levi jeans, Harley Davidson motorcycles and bourbon whisky. In response, Trump tweeted: “If the EU wants to further increase their already massive tariffs and barriers on US companies doing business there, we will simply apply a Tax on their Cars which freely pour into the US.” This is what happens in trade wars. Tit-for-tat measures are applied meaning that, in the end, all that happens is that consumers pay more for goods, which isn’t great for economic growth. It also is very difficult to work out when a tariff should apply. Define, for example, a German car? Is it one made in Germany or simply one made by a German company?
So which President Donald is right? Are trade wars good or bad?
BMW, for example, makes nearly all of the cars that it sells in North American, in the US. It employs more than 10,000 people at its South Carolina plant, principally making its “X” line of cars. Apart from just selling cars in the States, BMW is actually the largest exporter of cars FROM the US. A colleague’s BMW X3, which he bought in the UK, was actually made in South Carolina.
Frankly, there aren’t often many winners in a trade war. Immediately after Trump’s announcement, the
By targeting German cars Trump’s policy could therefore actually be costing US jobs.
“Trade wars are bad and easy to lose” – Donald Tusk, President of the European Council
Chart 1: U.S steel imports - Top 10 sources. YTD 2017 - percent of volume
Source: IHS Global trade atlas. YTD through September 2017 | US depeartment of commerce - global steel trade monitor
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter March 2018
Rules of origin
When deciding what tariffs to apply in trade agreements, a “rules of origin” test is carried out. This is of course also important when it comes to any new trade agreement between the UK and the EU after Brexit. Again, it is particularly difficult when it comes to cars. Is a Nissan made in Sunderland a Japanese car or a British car? What tariff, if any, would apply if it is then exported to (say) France? According to Mike Hawes, the CEO of The Society of Motor Manufacturers and Traders: “Generally rules of origin require around 50-55% local content. Currently in the UK, the average car has about 41% local content.” In reality the UK originating content could be even lower, with the 41% encompassing all inputs bought from UK suppliers, which may have imported them from elsewhere. (Centre for European Reform “Brexit & rules of origin…” 13 March 2018). This is an important factor in free trade agreements such as that we are seeking to negotiate with the EU.
the continent. British meat currently meets EU safety standard so they may be happy to accept this as a British export. Let’s then say that Britain then negotiates a separate free trade agreement with the USA. In order to obtain the best terms we compromise on some of our principles and decide to accept the now notorious “chlorinated chicken”. In the US it is relatively common practice to “wash” chickens in a chlorine-solution to kill bacteria. This is not acceptable in Britain or the EU as it is deemed to have unsafe levels of chlorate. Now this presents the EU with a problem. If they accept chicken exports from Britain, how do they know they aren’t actually getting a chlorinated chicken from the US? This means all chicken exports from Britain have to prove their origin, leading to costly checks and bureaucracy. These are known as “non-tariff” barriers which can have quite a substantial impact on businesses, quite apart from the need for more customs officers and controls. This is one reason free trade agreements are not quite the same as being part of a common market.
To understand why, let’s say we negotiate a free trade agreement allowing us to export chickens to
Global growth
What we do know is that trade is an important component of the global economy. If economies start putting up trade barriers then that could dampen global growth. It is therefore something we need to be watching carefully when managing your portfolios.
However, investors remain nervous and stockmarkets are probably vulnerable to any further bad news. If we do see any further weakness we may again use that as a buying opportunity.
Interestingly enough, Trump’s pronouncements have probably helped portfolios in the short term. The stockmarket sell off earlier this year was perhaps at least partly caused by expectations that US interest rates could increase quite sharply given the strong US economy. These expectations have been slightly tempered due to worries over trade, particularly since the resignation of Gary Cohn, Trump’s economic adviser who was known to have opposed new tariffs. Whilst this is seen as a potential negative for the US economy, the reduced prospect for interest rates have actually been seen as a positive both for stocks and bonds.
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter March 2018
General Economic Overview Whilst most major economies are showing strong growth there are some early signs that the pace of that growth may be softening, in particular in the manufacturing sectors. Globally, investment demand is rising and trade is buoyant although markets are closely watching developments following the recent imposition of tariffs by the United States on steel and aluminium imports. UK economic activity has been relatively subdued with the annual rate of growth slowing over the last 12 months. Inflationary pressures appear to have eased as the value of sterling against other leading currencies has steadied and oil prices have pulled back from recent highs. The reversal of the extreme monetary easing by several central banks over the next year or two is likely to provide headwinds for asset markets. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Many markets have recovered from the lows seen during the spell of volatility in February and most remain fully valued – no change in score over the month. We continue to see more value in Asia including China and Japan, and smaller companies within the UK.
-3
Fixed Interest The rise in global demand growth is pushing up inflationary expectations which is not a good environment for fixed-income securities. In addition, higher interest rates raise the prospect that some highly-indebted companies may struggle to meet payments.
-4
Commercial Property The UK commercial property market reflects the broader sluggish economic growth in the economy and we expect modest growth over the coming year. In particular, we look to avoid London offices and hold more in favoured sectors like industrials.
-3
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest, property and equity. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent EIM’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser. Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.