How Harmful Is A Trade War?

Last update on April 2, 2018.

Image Credit: lightspring / Shutterstock.com

 

At the beginning of every month, I brief members on how MoneyGeek's Regular portfolios have performed and comment on the state of the financial markets. In this update, I’ll also use a historical example to discuss how much damage a new trade war could have on the global economy.

 

March Performance of Regular Portfolios

The performance of MoneyGeek's Regular portfolios for the month of March 2018 were as follows:

 

Last Month

Last 12 Months

Since Apr 2013

Aggressive

-1.0%

+9.5%

+97.8%

Growth

-0.9%

+8.3%

+81.1%

Balanced

-0.7%

+7.1%

+65.4%

Conservative

-0.5%

+5.7%

+50.7%

Very Conservative

-0.4%

+4.6%

+37.1%

I've chosen to list below the performance of some of our competitors. For the sake of brevity, I've decided to show only those portfolios that have a similar risk profile to MoneyGeek's Regular Aggressive portfolio.

Please note that the globe and mail, where I get my data from, has recently revamped their site. I couldn’t find the exact mutual funds that I had been tracking in the new site, so I’ve had to replace them with similar funds. The new funds may have rather different performance records from the old ones.

 

Last Month

Last 12 Months

Since Apr 2013

RBC Select Aggressive Growth

-0.7%

+7.1%

+37.3%

TD Comfort Aggressive Growth

-0.7%

+2.0%

+42.9%

CIBC Managed Aggressive Growth

-0.3%

+7.5%

+46.7%

Canadian Couch Potato Aggressive

-0.5%

+7.1%

N/A

In contrast to our competitors, MoneyGeek’s Regular portfolios employ stocks/ETFs that follow the value investing strategy (QVAL, IVAL and BRK-B), and also allocate a larger percentage of the portfolios toward Canadian oil and gas stocks (XEG.TO) and gold (CGL-C.TO). If you would like to take a look at our portfolios, I invite you to sign up for our free membership.

In March, Regular portfolios underperformed relative to our competitors. The value investing ETFs performed somewhat worse than the rest of the stock market. Although oil stocks and gold went up during the month, they weren’t able to offset the decline in the value investing ETFs.

Talks of an impending trade war jolted investors during the month. It all started on March 2 when Trump announced tariffs on imported steel and aluminum. Critics charged that such actions would lead to a trade war, to which he responded, “Trade wars are good, and easy to win”. A few days later, Trump’s economic advisor, Gary Cohn, resigned in protest of the new policies.

The steel and aluminum tariffs will hurt many countries in Europe, so the European Union retaliated in kind by placing tariffs on an extensive list of U.S. products. Lamenting this process, the head of the European Commission exclaimed, “This is basically a stupid process, the fact that we have to do this. But we have to do it.”

Trump wasn’t done, however. On March 22, he announced a new round of tariffs on some $50 billion worth of Chinese imports, on the grounds that China has been stealing U.S. technology for years. As with the EU, China responded in kind by proposing tariffs on an assortment of U.S. products, and is apparently contemplating additional measures.

The events in March clearly heralded the beginnings of a trade war. While investors shrugged off the opening salvos of tariffs concerning steel and aluminium, they were less sanguine about the developments regarding China. In the two days following the announcement of the Chinese tariffs, the U.S. stock market fell by 4.6%. Although the stock market has recovered somewhat since then, it is still trading below where it was before the tariff announcement.

But are investors right to be concerned? How terrible can a trade war be for the economy? These are good questions, and ones that I doubt anyone has definite answers to. But I believe that history can offer us some clues.

 

Lessons from the 1930s

The U.S. experienced its most recent trade war in the 1930s. The stock market had crashed in 1929 and the economy soon tanked as well, marking the beginning of the Great Depression. When the economy suffers, people tend to want to prioritize their own welfare ahead of others’, and although a country usually gains economically by maintaining international trade, voters often don’t perceive it that way. The protectionist sentiment led to the creation of the Smoot–Hawley tariff, which introduced punishing tariffs on agricultural and industrial imports. Other countries retaliated in kind, which brought about a trade war.

Economists have since studied the effects of this trade war to discern how much impact it had on the economy. Unfortunately, they haven’t been able to measure the effects with much certainty, because there were a lot of other things going on during the same time period. The world still had to grapple with the effects of a stock market crash, and it was still dealing with the consequences of adhering to the gold standard. It’s hard to disentangle the effects of a trade war from these others factors.

Still, economists tried their best, and they found that the trade war likely did have a negative impact on the economy. However, the degree of impact on the economy was perhaps not as great as initially feared, coming in at below 2% of the world GDP. By comparison, the world economy grew by 3% per year on average in the 20th century, so the tariffs alone wouldn’t have been able to push a “normal” growing economy into a recession, in theory.

Unfortunately, that doesn’t mean we can breathe a sigh of relief. Before 1930 when the Smoot-Hawley tariffs were enacted, global trade as a percentage of world GDP had peaked at 30%. Today, that percentage is roughly double, at 60%.

Furthermore, the global supply chain was much less sophisticated back then, which allowed countries to quickly develop domestic alternatives to imports that suddenly became expensive. For example, if imported wheat becomes more expensive, domestic farmers could decide to plant more wheat. By contrast, it would take many years and a great deal of capital for a country to develop its own semiconductor industry today.

Because of the greater prevalence of trade and the increased sophistication of supply chains, I believe a trade war today will be much more damaging than it was in the 1930s. If we assume that the trade war will knock 4% from the world GDP, it will be enough to swing the world from growth into recession.

If the world does enter a recession, historical evidence suggests that the stock market will follow. Now, there are a lot of unknown variables so I don’t feel compelled as of yet to change the composition of MoneyGeek’s portfolios. But I’ll keep a close eye on the current situation, and act if I feel that’s necessary.

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