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Unless you’ve been living under a rock, you may have noticed that the US and China have been getting…a little testy with each other.
–CNN, May 13, 2019
–CNN Business, May 22, 2019
–CCN, May 23, 2019
OK so what’s going on here? Why are the US and China in a trade war? What does it mean for our investments? And what changes (if any) are we making to our portfolio in response?
Let’s get into it!
It wasn’t Trump’s Fault (This Time)
FIRECracker has a, let’s say, “complicated” relationship with the Chinese government.
To briefly summarize her family’s long and tortuous journey to Canada, FIRECracker’s family lived under brutal persecution under the Communists while they were in China. Because her family came from the wrong background, they were labelled as “enemies of the people” and as such were frequently targeted by the Chinese government. Multiple family members were killed during the Cultural Revolution, and her dad spent 10 years in a labour camp. Not fun.
After her dad (with great difficulty) got into university, he was able to leave by applying for a student visa abroad. He chose Canada to study in order to get his PhD. His immediate family, meaning FIRECracker and her mom, were forced to stay behind in China to act as de-facto hostages. The understanding was that he was to return to China after he completed his PhD or “something bad” would happen to the family he left behind.
Then the Tianamen Square massacre happened. You may have heard of it.
The resulting media frenzy and international pressure forced the Communists to stop with the whole “killing dissidents” thing, so when travel restrictions eased, FIRECracker got the Hell out of Dodge and immigrated to Canada.
Anyway, the point of this whole story is that FIRECracker understandably inherited an extreme distrust of Communists because of all this. Which is why to this day she has a golden motto that she continues to abide by, and that rule is:
Never Trust Communists
So what does this have to do with the US/China Trade War?
Ever since Trump got elected, he has made it a habit of starting trade wars with pretty much everyone he was doing business with. First Canada & Mexico, then all of Europe, and now finally China. With allies such as Canada, Mexico, and Europe, those trade wars made little sense because those countries were, for the most part, playing by the established rules of their existing mutually-beneficial trade relationships. Pissing off allies in order to extract concessions that were, at the end of the day, really minor, made no sense.
China was a different story. Trump and his trade negotiator Robert Lighthizer felt that China was stealing US intellectual property, which they absolutely were (1 in 5 US companies reported having their IP stolen by China in the last year). There were other issues such as accusations of currency manipulation and a $500B trade deficit, but the main issue was the IP theft. In order to do business with China, companies had to form joint ventures with Chinese firms, at which point all their IP would get stolen and copycat products would start appearing. That shit ain’t cool, and is one of the very few things I agree with Trump on.
So after the initial chest thumping and penis-waving, it looked like China and the US were actually getting things done. Trump agreed to halt all further tariffs as a show of good faith, and it looked like China and the US were about to sign a grand bargain that resolved most of the issues the Americans had raised.
Then China decided to pull a switcheroo on the agreement, sending out an altered version of the text in which all the things China had agreed to had been removed. Apparently, they had been hoping that the US would treat the document the way we all treat software EULAs, and hit “I agree” without actually reading it.
When the ruse was discovered, talks broke down, tariffs got raised again, and that’s the situation we all find ourselves in.
Which just goes to prove once again FIRECracker’s motto.
Never Trust Communists.
Don’t Bet On China…
Our distrust of Communists also seems to be shared by the investment community. Despite the fact that China is the 2nd largest economy of the world, it doesn’t seem to show up very much in world stock indexes. The MSCI EAFE Index for instance, only holds a weighting of 3% in Hong Kong. For comparison, it holds 7% in Australia and 24% in Japan.
The reason for this is that the Chinese stock market isn’t nearly as well-regulated as those of other developed countries. If a stock’s price starts to fall, the government can (and will) freeze trading to prevent losses. Accounting transparency is a huge problem. And while insider trading is generally considered a crime in Western countries, it’s deemed “hilarious” by the Communists. That’s what happens when you have a government acting as both the regulator and the owner of many of the companies on the stock market.
Never Trust Communists.
J.L. Collins has argued that there’s no need to own an International Index over the US Index since so much of US companies’ profits originate from overseas, and while we may disagree on that, when it comes to exposure to China I’m 100% in agreement. I’d much rather own stocks domiciled in countries with proper regulators that do business in China rather than Chinese companies themselves. And if you build a portfolio similar to the one we write about in our Investment Workshop, that’s exactly what you end up doing.
…But DO Bet On the World
But despite our inherent distrust of the Chinese government, this trade war, like any geopolitical event, is why we don’t bet on individual countries based on stuff we read about in the news. Instead, we hold an equally balanced portfolio of stock markets all around the world.
I don’t know when this trade war will end, but by holding the world we are naturally insulated from the impact of any one country. Even if this trade war drags on for years, Chinese and American companies aren’t going to just sit there and patiently wait for their respective govenments to stop squabbling. They’ll eventually look elsewhere around the globe to sell their products, and whether that means China increases their trading relationships with Europe or South America steps in to service the American market, by holding the world indexes you’ll benefit wherever it goes.
And also, in the grand scheme of things it’s important to remember that the world continues to live and prosper. I recently pulled up my trading platform to dump in some spare cash I had lying around, and while the near-term performance of the US stock market looks scary…
When we pull back the YTD performance of the same index, the impact of these tariffs really come into perspective.
On the whole, the US (and the world) economy is still in pretty great shape, and even though the two largest economies are currently in a trading war, as long as it doesn’t develop into a real war I’m not too worried. The two sides will eventually resolve their differences or some other country will step in to fill the void.
Either way, we win.
But seriously, Don’t Trust Communists.
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