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Tariffs: Clarity, Not Chaos in the Numbers


The announcement of the implementation of tariffs on steel and aluminum has once again awakened investor anxiety. The implementation of a tariff on imports (25% on steel and 10% on aluminum) is very anemic in actual numbers, but that is not the reason the markets are reacting in a heightened risk-off manner. There is clarity in the numbers, but chaos in the reaction to the “what if’s.” Let’s do a quick review:

  • The belief is that this will not apply to NAFTA (North American Free Trade Agreement) countries, which would be a significant development as it would exempt a large source of aluminum from Canada.
  • According to the U.S. Department of Commerce, China accounted for over 600,000 tons of aluminum products. If the tariff spills over to the product component versus raw, then a potential reaction from China becomes a bit more concerning.
  • Trade wars often have impacts on the markets that – while tumultuous in going through it – often lead to a longer-term compromise, which leads to a more mutually beneficial arrangement. Consider the U.S.-Japan auto trade war of 1993-1995 and U.S.-China steel in 2002.
  • According to Credit Suisse, the impact of the tariffs on China and Korea is quite minimal. The project that it has the potential to impact is Korea’s GDP, potentially by 0.2%, and even less so for China. Vietnam is the only potential outlier where volatility in aluminum and steel exports to the United States could have a larger impact.

Perhaps the bigger surprise is that we are surprised at all. Since 2008, we have seen a ceiling of globalization as measured by the amount of global economic activity as a percentage of exports. In the Early 1980s the level of exports to global economic output was 38%, by 2008 this was at 60% and unchanged since. Since 2008 we have seen over 2,500 negative net tariffs implemented worldwide. The reaction by countries across the globe to The Great Recession (or the biggest and broadest bank run in history) was to silo and ring fence their countries. Some might argue the United States was a bit late to this game relative to the world.

As such, there are a few areas that are extremely important to allocating assets.

  • Globalization is disinflationary and Protectionism is inflationary. With globalization having, at best, diminishing rates of return from a growth perspective, the insulating component of protectionism begets a more improved environment for inflation. The metrics have already been increasing systematically over the last two years and we believe it will continue. We don’t foresee hyperinflation, but a steady increase with increased rhetoric form the Federal Reserve, which is weighing heavy on the Treasury Market. As such, we are favoring Energy, Materials, Commodities and floating and inflation-linked income notes.
  • Since The Great Recession, we have also seen significant shifts in Europe and China from an export-laden-driven economy to move to balance that with increased focus on domestic consumption. As such, diversification into international equities and specifically these areas make sense to potentially lower the average correlation of assets within a portfolio.
  • Going forward, we see the recent moves on the tariff front as a broader-based negotiating tactic to moderate certain trade agreements with particular trade partners. The discussion of a Trade War is not out of the question, but also needs to be put in perspective regarding the end game of past disagreements. Mark Twain said, and we’ve re-quoted it often, “History doesn’t repeat itself, but it does rhyme.”
  • Perhaps the more important impact is the increased volatility in the U.S. dollar. The last trade war with China in 2002 corresponded with a 12.8% decline in the value of the U.S. dollar. While that is being thrown around as another scare tactic, take note that that decline also corresponded with 1,505 basis point drop in the 10-year Treasury as the economy was recovering from the recession in 2001. A similar rate of decline here would have to correspond to a recession already occurring which is not corroborated by nearly every economic metric we review. We continue to see a broad trading range for the U.S. dollar this year. 

 

CRN: 2018-0302- 6460 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

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