US-China Trade-War Tensions Ratchet Up

October 3, 2018

Chimerica becomes a chimera.

This is a summary of the Q318 Economic Outlook; you can also read the full-length paper. 

Niall Ferguson, a well-known historian and Harvard University professor, coined the term “Chimerica” in 2006. It was a clever way to underscore the fact that the Chinese and American economies had become so intertwined that they could be viewed as one economy. As Professor Ferguson observed in a 2009 article, "The Chinese did the saving, the Americans the spending. The Chinese did the exporting, the Americans the importing. The Chinese did the lending, the Americans the borrowing." That symbiotic yet unsustainable relationship started fraying a decade ago in the aftermath of the financial crisis. Now, the ratcheting up of the trade-war tensions between the two has become the leading preoccupation of investors.

42% US and China combined total of last year's world nominal GDP

Although nobody wins in a trade war, even those White House advisors who hold a pro-trade bias believe that the U.S. will get hurt less. Investors appear to have reached the same conclusion. While the U.S. flirts with new all-time highs, China has fallen into bear market territory. By working out a broad agreement on a new NAFTA deal, and backing down on the threat of tariffs on European and Japanese autos and parts, it seems the Trump administration realizes it's better to gain allies in its battle against China than fight on multiple fronts. Whatever happens between the two countries will likely have global implications across economies and financial markets as together they were 42% of last year's world nominal GDP. 

In addition to rising trade tensions, we see the Federal Reserve (Fed) as another potential threat to the U.S. equity bull market. We agree with the Fed’s view that the funds rate is still below the so-called neutral rate of interest, above which the stock market has historically run into trouble. The question is how high the federal-funds rate will ultimately go. One can argue about whether the valuations embedded in the U.S. equity market are high, especially when measured against other global stock markets. A sharp rotation out of large technology companies could be somewhere down the road.

In view of the uncertainties facing investors at the present time, the prediction game is even more challenging.

Predicting the future is a hazardous venture most of the time. In view of the uncertainties facing investors at the present time, the prediction game is, perhaps, even more challenging. Accordingly, we believe in a diversified approach to investing. Although maintaining exposure to risk assets may feel uncomfortable, for investors with long time horizons, it pays to keep in mind that mis-timing entries and exits into and out of equities can be costly. At this stage, mistiming one’s exit is the greater concern.

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This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information is for educational purposes only and should not be relied upon by the reader as research or investment advice.

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