The escalation of Donald Trump’s trade war with China has unsettled global stock markets, prompting the question: is this a buying opportunity? The answer is: probably not.
To see why, remember that there are only really three types of stock market fall: those caused by overreaction to bad news; those caused by increased risk aversion; and those caused by expectations of lower future profits and dividends. The first two are buying opportunities, at least for the braver investor. The third is not, but it is the reasonable response to the trade war.
The fact is that international trade is a big cause of prosperity. Anything that jeopardises it therefore threatens to make us poorer. Shares should therefore fall in response to a trade war, because future profits will be lower than they otherwise would be.
One reason for this is simply that cheap imports raise real incomes, allowing consumers and companies to spend more on everything, including more domestic goods and services. This is one of the so-called Wal-Mart effects that boosted US growth in the 1990s and early 2000s.
Also, international trade raises productivity growth. Competition from importers forces domestic companies to increase efficiency or to move up the value chain. Competition from other exporters has a similar effect on exporting companies, who can learn best international practice from other companies by listening to overseas suppliers and customers. It is partly for these reasons that the Office for National Statistics (ONS) has estimated that UK companies that engage in international trade are on average 70 per cent more productive than ones that don’t. What’s more, in driving the worst companies out of business international trade forces labour and capital to find more productive uses.
Better still, trade encourages companies to innovate simply because if you can sell your products worldwide, your incentives to develop great ones are much greater than they would be if you only serve your domestic market.
For these reasons Jae Bin Ahn and Romain Duval, two International Monetary Fund (IMF) economists, have found that “productivity growth has been faster in countries and industries that have been more exposed to China’s opening to trade”.
All this is consistent with two big facts. Fact one is that the slowdown in world trade growth since the financial crisis has coincided with a slowdown in labour productivity growth around the world. According to the Dutch official statistics group CPB, world trade volumes grew by 6.3 per cent a year in the 10 years to 2007, but have risen only 1.7 per cent a year since. And UK productivity rose 2.2 per cent in the 10 years to 2007, but only 0.2 per cent a year since.
Fact two is that there has for years been a close correlation between annual growth in world trade and equity returns. Falls in world trade in 2001, 2008, 2015-16 and late last year were accompanied by falls in share prices. And strong world trade growth in the late 1990s, mid 2000s, 2009-10 and in 2016-17 all saw shares do well. Granted, the causality isn’t wholly from trade to equity returns – falls in growth expectations, appetite for risk or tighter credit conditions can cause both to fall – but it’s possible that some is.
Anything that hurts world trade, therefore, depresses incomes and profits. And this warrants permanently lower share prices, relative to what we would have under freer trade.
From this perspective, it is little comfort that President Trump’s tariffs so far apply only to a few goods – although some regard his blacklisting of Huawei as a protectionist measure as much as a national security one. The trade war “may well escalate again” says Timme Spakman, a trade expert at ING. This danger alone is a reason for companies to delay investing in exports and hence a reason for trade to stagnate. And it’s a problem for all countries, not just China – one reason for falling output in Germany last year was a drop in orders from China. Policy uncertainty reduces investment and share prices.
Such uncertainty is magnified by the fact that tariffs don’t work well in their own terms because they do little to reduce trade imbalances. Official figures show that the US’s trade deficit in goods actually widened last year from $807.5bn to $891.3bn, although it has narrowed a little so far this year.
There’s a simple reason for this. The trade deficit is very closely correlated with the overall current account deficit, which itself is by definition equal to the excess of domestic investment over domestic savings. Tariffs therefore only reduce the trade deficit to the extent that they either raise savings or cut investment. They can do both, if the revenue from tariffs is used to reduce government borrowing or if companies respond to higher prices of steel by investing less. But these are weakish mechanisms. It’s likely therefore that the US’s deficit in goods will remain large. And given that President Trump thinks this means the country is “losing” billions of dollars there’s a danger that he’ll double down and extend the tariffs further. Or at least there’s sufficient risk of this to deter companies around the world from investing in exports.
So no, the trade war is not a buying opportunity, unless you believe it will soon be resolved – which is no more than a bet on one of several possibilities.
Yes, there are still reasons to be bullish on equities: the dividend yield on the All-Share index is above average and global investors’ sentiment, as measured by net foreign selling of US shares, is weak. At best, though, the trade war is a reason to be less bullish than a few weeks ago.
