Monday, the S&P 500 declined 2.4% as China announced retaliatory tariffs after Friday’s negotiations ended without an agreement. This decline came on the heels of last week’s swoon of 2.1%. However, small stocks came under increased pressure, falling 2.2% last week and another 3.1% yesterday. While many think small cap stocks are less vulnerable to trade disputes than their large cap brethren, they are more volatile and have fewer resources to change their supply sources.
Let’s recap what transpired recently in the on-going trade dispute between the US and China to get us to this point. Just over a week ago, China refused to move forward unless all recent US tariffs were removed. Consequently, they returned the trade deal draft with edits that deleted commitments to change laws on protecting US intellectual property, trade secrets, competition policy, access to financial markets, and currency manipulation. The President insists that some tariffs stay, temporarily, to ensure compliance. In response, the President began last week by threatening to raise the current 10% tariff on $200 billion in Chinese exports to 25% if an agreement were not reached by Friday. Unfortunately, Friday came and went and the Chinese delegation went home without completing a deal. As result, President Trump went through with his threat and raised the current tariff to 25%.
The Chinese retaliated by imposing additional tariffs of up to 25% on $60 billion in US goods. These tariffs, on over 5000 products, are scheduled to begin on June 1st. In addition, the editor-in-chief of the Global Times, a newspaper with ties to the Chinese government, tweeted that Chinese scholars are studying the prospect of dumping US Treasuries. China still holds about $1.3 trillion in US debt and any large scale sale could disrupt the markets. However, this threat is more of a bluff than a probability as it would be self-defeating. Dumping Treasuries would drop the price on the very same securities that the Chinese are trying to sell. In addition, any ensuing panic would eventually lead investors to seek a safe-haven, which traditionally has been US Treasuries, which in turn would prop up Treasury prices. Regardless, to quell markets the Fed could initiate quantitative easing, thereby buying Treasuries and lowering yields.
For now, we will have to watch to see if the discord increases. Like it or not, this is the President’s negotiating style. While we still expect a trade deal to be reached, we would not be surprised if tensions escalate in the coming days or weeks. The two sides are scheduled to meet next in June for the G20 meeting in Japan.
As I have stated before, we are against tariffs. Tariffs are simply a tax on trade that reduces productivity, decreases output, raises costs, and lowers employment. However, we believe pushing China to protect intellectual property rights and instill market reforms could lead to a more productive trade relationship for both China and the US.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his MBA at Boston University.