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Will Higher Tariffs Halt Global Growth?
Trade worries can create opportunities for investors. Take a closer look.
By: Edward Jones
Fears about trade wars contributed to higher market volatility in the first half of this year, worrying investors. Although uncertainty and related market volatility are likely to remain high, we believe many of the currently proposed tariffs won't be implemented.
Synchronized global growth ahead
After several years in the doldrums, world economic growth rose faster than expected in 2017, and the outlook remains positive. Despite the pause in first-quarter growth in Europe and Japan, there are signs of improvement, and the International Monetary Fund (IMF) expects the global economy to expand by 3.9% in both 2018 and 2019. Monetary policies in Europe and Japan continue to be expansionary, helping keep interest rates low and supporting stronger economic growth with few signs of higher inflation. And earnings of foreign companies have continued to rise. In our view, these positive indicators make international equity investments attractive.
Trade rises with global growth
Trade plays a vital role in global economic growth, which is why policies that could disrupt global trade receive a lot of attention. As the chart above shows, trade has increased as a percent of the U.S. and most other economies over time. Most of the rest of the world is more tied to trade than the U.S.: Trade affects about 65% of world output, compared with about 30% of the U.S. economy. China's exposure to trade rose rapidly when it drove growth by increasing exports. As China has shifted to growth led by domestic consumption, its sensitivity to trade has declined.
The U.S. consumes more than it produces – that's why the country runs a trade deficit and has a low savings rate. The trade deficit has generally increased as the economy grows – and may increase further due to current pro-growth policies. Looking a little deeper, the overall trade deficit combines goods and services. We import more goods than we export, but the opposite is true for services. The trade surplus in services is smaller but growing, and should continue to increase as incomes rise around the world.
Trade worries can create opportunities
We don't expect a trade war, but if one were to break out, we think the biggest impact would be slower U.S. growth. As U.S. consumers and businesses pay higher prices, they'll buy less and search for other sources, disrupting global supply chains. A trade war with Europe or China would also hurt their growth as well as reduce prospects for the rest of Asia. The resulting slower global economic growth would dampen our outlook.
In our view, periodic worries about higher tariffs and trade wars have created opportunities for investors in small- and mid-cap U.S. stocks and international equity investments. We recommend adding both if appropriate.
• Small- and mid-cap U.S. stocks – Signs of improving U.S. economic growth, the reduction in the corporate tax rate and elevated international tensions have favored smaller U.S. companies, which generally have higher tax rates and less international exposure. As a result, they outperformed large-cap U.S. companies in the first five months of 2018. We think they remain well-positioned.
• International equity investments – Synchronized global growth continues to support our positive outlook for developed-market equities, which have higher dividend yields and better valuations than U.S. equities. We prefer them to emerging markets, where we think the risks and opportunities are balanced.
Ongoing negotiations toward updated agreements – rather than a trade war – support our positive outlook for expanding global economic growth. Stay on track with a broadly diversified portfolio that has an appropriate mix of U.S. and international equity investments as well as fixed income.
Source: World Bank, 12/31/2016.
Investing in equities involves risk. The value of your shares will fluctuate, and you may lose principal. Small- and mid-cap stocks tend to be more volatile than large company stocks. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.
Edward Jones - Mae Luchetti