The U.S. – China trade dispute has carried on for about eight months with no agreement in sight. To date, the U.S. has imposed tariffs on about $250 billion in Chinese goods, representing about half of what the U.S. imported from China last year. In turn, China has retaliated with its own tariffs on $100 billion in imported goods.
So far, the global economy has avoided a trade breakdown, as exports and imports are growing steadily for both the U.S. and China. However, small cracks are forming in the global economy perhaps due to the impact of trade tensions, and leading trends show a prolonged dispute. More severe tariffs could exacerbate these effects.
Global trade has yet to weaken significantly. China’s exports and imports have remained steady, even after the latest round of tariffs on $200 billion in goods kicked in on September 24. Last month, Chinese exports jumped 15.6% in dollar terms, the strongest growth in three months. While China’s exports to the U.S. were near a cycle high in October, U.S. imports comprised just 6% of China’s imports, the lowest level going back to 1999. Solidly growing Chinese imports shows that total demand hasn’t wavered significantly, and the country has found alternative sources for goods amid tariffs.
In September, U.S. exports grew 1.5% while U.S. imports rose 1.5%, both at the strongest pace since the trade dispute began in March. Also, in September, U.S. imports (adjusted for inflation) grew at the fastest pace over the year since 2015 as consumer demand continued to strengthen. U.S. exports, which reflect the health of other regions, grew 6% year over year, a solid pace of growth and well above the 4.3% average growth in 2017.
Currently, strong global demand is outstripping any interruption from trade. To us, this demonstrates the interconnected nature of the global economy, with solid U.S. economic growth making an increasingly heavy contribution to overall global growth. Trade worldwide also may be benefiting from a surge in activity earlier this year when firms rushed to beat tariffs’ implementation dates. Some of this effect may still be having an impact, given that the U.S. has threatened to double the amount of outstanding tariffs and increase the rate on a significant portion of existing tariffs if no deal is reached by the end of the year.
However, economic cracks have started to appear, largely in leading indicators as producers brace for a decline in demand and other unintended consequences of the trade dispute. The most telling trend is the global decline in manufacturing activity, which is considered a bellwether for economic growth. Ironically, China’s shift to sourcing from other regions hasn’t significantly lifted manufacturing in other areas. Manufacturing in the Eurozone declined to a two-year low in October. Markit’s gauge of Chinese manufacturing health fell to 50.1 last month, on the brink of what Markit considers “contraction” territory.
China’s industrial profit growth has also slowed for five straight months to close to the smallest gain since December 2016. Declining manufacturing health could come from several sources, including political crises in Europe and emerging markets. The global economy remains relatively fragile in its post financial crisis “new normal.”
U.S. manufacturing health remains the strongest of all global regions, but deterioration in the underlying data (off meaningful strength) is spreading. Wholesale inventories have been climbing at their fastest pace since 2015, indicating companies’ expectations for stronger consumer demand. However, unfilled orders for durable goods continue to increase with inventories, hinting at breakdowns in the supply chain as manufacturers and firms digest growing labor shortages and rising input costs.
Trade tensions may have had an effect on U.S. businesses, some of which seem to have delayed capital investments because of trade uncertainty. In September, growth in new orders for nondefense capital goods (excluding aircraft) our best proxy for capital expenditures, fell to the lowest pace in 18 months. Last month, the Institute for Supply Management’s measure of new export orders fell to a 10-month low, while its gauge of new import orders has hovered around the lowest level in a year. New orders are viewed as a leading component for manufacturing and the economy (rising orders will typically lead to increased production), so the drop-off in new orders could forecast slower manufacturing growth. The slowdown in investment is especially telling considering fiscal stimulus has incentivized firms to increase capital expenditures.
Financial markets have suffered. The back and forth threats between the U.S. and China may have contributed to market volatility. In October, global stocks (tracked by the MSCI All-World Country Index) posted their worst month since May 2012, while the S&P 500 Index fell the most since September 2011. However, trade issues have yet to change underlying economic conditions in either China or the U.S. That does not mean they won’t if there isn’t a resolution.
Markets often respond to rate of change in growth and earnings. Although both growth and earnings are fundamentally sound, the fact they are slowing means that markets are adjusting to lower levels. The Federal Reserve continues to raise short-term interest rates while inflation remains constrained. Slowing growth combined with rising rates and low inflation is a cocktail for higher volatility. We have been expecting increased volatility. Now that it is here, though, it feels very uncomfortable. Markets often behave this way
as they transition from high growth names to value. This transition could last for several months.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
• The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
• Data provided by LPL Financial and Markit.
• All investing involves risk including loss of principal.