In war, the injury of non-combatants is called “collateral damage.” Now that the trade war with China is official, American investors are going to feel it in their retirement accounts.
What is a Trade War?
A trade war starts when one country issues tariffs (border taxes) on another country’s imports in an attempt to shield domestic industry from foreign competition, and the other country retaliates with trade policies intended to hurt the first country’s economy. Usually, trade wars devolve into a volley of escalating tariffs and embargoes as each country strives to economically cripple the other. While tariffs and trade wars may foster limited job creation in the short run, they inevitably bog down in high inflation, falling GDPs, and reduced investor confidence as international trade seizes up and the cost of goods and production rises for all involved.
The “Biggest Trade War in Economic History”? Not Really
After the U.S. government’s tariff on $34 billion in Chinese goods took effect at midnight on July 6th, Beijing issued a statement that the U.S. had “launched the biggest trade war in economic history so far,” and instituted its own retaliatory tariffs on American goods, including cars and soybeans (full list of imposed and threatened tariffs available here). Even ally nations such as Canada and Mexico have been dragged into the fray.
How did we get here? And, perhaps more importantly, where do American investors go from here?
While a full account of the trade war’s causes is best left to the economists and political analysts, the conflict centers on a trade deficit between the U.S. and China. A trade deficit exists when the cost of a country’s imports exceeds the value of its exports. Currently, the United States imports $336 billion more in Chinese goods than it exports. This is due to a bevy of factors, including consumer preferences, the dollar’s status as a global reserve currency, and Chinese policies that place explosive economic growth ahead of workers’ health, safety, and purchasing power. In exchange, China invests $30-$50 billion annually in the U.S., raising stock prices, moderating interest rates, and supporting new businesses and real estate developments.
America’s trade deficits are the result of complex economic relationships with many benefits and drawbacks; it isn’t as simple as one country “losing” economically to another. President Trump sees the trade war as a way to force China’s hand in reducing the trade deficit, among other things. You can read a summary of the demands from both governments here.
While the tariffs are certainly painful, the current spat is not, as Beijing claims, the biggest trade war in history. That designation still belongs to the trade war the U.S. set off with the Smoot-Hawley Act in 1930. However, this is the ugliest trade brawl America has been in since. To say that retirement has changed in the last 90 years is more than an understatement, considering that Social Security didn’t even exist until 1935. No one is quite sure how severely a full-blown trade war will impact domestic and international markets, but we do know what kind of shrapnel American retirement accounts are likely to take in the next few years.
Caught in the Crossfire
Trade wars work, essentially, as pressure cookers. Governments pass reactive tariffs quickly, but the actual effects of these policies take months and even years to manifest as the combatants attempt to broil each other in the growing heat of economic turmoil. American investors are unlikely to feel the effects until 2019, and, barring the recent spate of market volatility, the U.S. economy has seen a solid upswing in the first half of 2018. This means you have more than enough time to secure your assets. Here’s what you can expect:
- Higher Market Volatility
The stock market is as much an emotional barometer as it is an economic one. Trade wars generate anxiety, and when investors get scared, they sell, driving down prices as the market is flooded with shares. We’ve already seen a few of these “tariff tantrums” when the tariffs were first proposed in April and May. While a serious pullback is unlikely, now is the time to reassess your risk and diversify your holdings. Read our guide to market volatility here.
- A Lagging S&P 500
According to a recent analysis conducted by John Butters at FactSet, an estimated 60% of sales growth, and 40% of sales, for companies in the S&P 500 index come from overseas. In the last two weeks, the sales projections for these companies have already started to fall. The S&P 500 is a favorite investment for retirement accounts such as 401(k)s and insurance products such as variable annuities. As a result, constriction of international trade is bound to have an outsized impact on retirees. You may want to look to CD’s, multi-year guaranteed annuities, and other principal-protected products that will take advantage of increased interest rates and protect your assets from falling stock prices.
- Higher Inflation
One of the major effects of a trade war is increased inflation. Foreign competition tends to keep the price of domestic resources low, while inexpensive raw materials from overseas help moderate the price of American-made products. As both production and materials become more expensive, manufacturers increase the price of their goods and pass on the rising costs to consumers. If you’re planning for retirement, you’ll need to take the increased cost of living into account. If you’re already retired, make sure you adjust your budget. In either case, it may be time to consider an annuity with a rising income rider that will grow your income to offset future inflation.
- Higher Interest Rates
The Federal Reserve has already announced plans for a 1.5-1.75% interest rate increase over the next two years, but as the trade war causes inflation to swell, that number is likely to rise. Rising interest affects everything from APR rates on credit cards to bond prices and CDs. Be ready for debt to become more expensive and multi-year fixed interest annuities to become more lucrative.
Trade wars can be frightening and confusing for even the most level-headed investors, but the traditional market advice still stands firm; draw your shutters and sit tight. Ride out the storm.
Edited by: Sara McKinney
saractag@gmail.com
Sara is a recent graduate of Kalamazoo College and a new addition to the Cowen Team. Her responsibilities include IT support, event planning, and general administrative assistance.
