Trade wars matter, but not that much

Georges Ugeux, CEO | Galileo Global Advisors 

Matt Phillips made an unambiguous conclusion in the New York Times this week, warning Wall Street’s Sky-High Expectations Are About to Collide With Reality. Phillips points at the bleak outlook following the most recent corporate earnings trends. He is right in reminding investors of the real signs we should pay attention to — but too often ignore.

What is the disconnect?
The equity market today is at the same level as it was a year ago. During those same months, an accumulation of negative information should have commanded some cautiousness among investors. However, equity market participants don’t seem that concerned. There is a structural inability of Wall Street to gauge the possible consequences of structural changes. The time horizon of the largest investors does not go very far, and traders live day by day.

Guy De Blonay, fund manager, states that “eighty percent of daily volume in the U.S. is done by machines, so what you get is a lack of focus on earnings, a lack of focus on outlooks and you just get short-term movements based on very specific data that is released every day and that creates noise.”

Instead, political instability, economic slowdown, and the uncomfortable increase of the US budget deficit and public debt are crucial to understand the long-term financial climate.

International trade: the misguided focus on China
The US GDP is around $20 trillion, imports represent $3.1 trillion or 15% of the GDP. The deficit itself represents $1.4 trillion or 7% of the GDP. Those numbers do not include services (75% of the GDP): this is where the US dominates the world. The biggest dependency of the United States on imports is in automotive and consumer goods, where the trade deficit amounts to $600 billion.

Reading the media, it seems that the United States is fighting a trade and monetary war with the entire world, and especially with China. Market fluctuations are reported to reflect the sentiment of investors confronted with these sanctions.

But let’s look at the stakes. In 2018, US imported $539 billion from China, or 2,5% of the US economy and 15% of the US imports. The trade deficit with China is therefore limited to 2% of the US GDP. The value of stocks should not follow the vicissitudes of an absurd negotiation, directed by an immature President who would like the Chinese to collect dirt on his opponent for the next presidential election.

Furthermore, the US’ largest deficit with China is in consumer and electronics ($ 160 billion): it is massively due to the import of electronic equipment by US companies who prefer to produce their smartphones and tablets in China.

The budget deficit in an economic slowdown is the new reality
The deterioration of the US economy is a serious cause of concern, that rarely appears on market comments. For 2018, the budget deficit amounted to $779 billion. At the end of September 2019, it raised to $1.1 trillion. Adding the average $200 billion monthly deficit, the US’ deficit will reach a $1.3 trillion. this means the US budget deficit will increase by 66% in one year (yes, two third).

A slowdown of the forecasts for the growth will definitely reduce the revenues of Uncle Sam and will increase the fiscal deficit in 2020. The growth of the GDP in 2018 was 3.1%. At best 2019 will be 2.4%.

The new reality is a country whose financial stability is vulnerable: Wall Street knows those numbers, but shrugs its shoulders, as if it did not matter — at least not for now.

Compliments to Galileo Global Advisors , member of the EACCNY. This article appeared at Medium on Oct. 16