At the heart of President Trump’s policy is his conviction that China has used predatory tactics to challenge American technological dominance. He has accused the country of obliging U.S. corporations to trade technology for access to the Chinese market, as well as outright cybertheft.

Initially, the Trump administration placed tariffs on industrial products so that American consumers would not be impacted. However, the list of Chinese imports has subsequently expanded to a wide range of household products, from electric lamps to fish sticks.

Note that import tariffs affect entire supply chains in addition to the specific goods taxed. Ultimately, this could lead to the distribution of cheaper raw materials that could impact the quality of consumer goods and manufactured commercial products.

“Although tariffs could cause prices for consumer products ranging from cars to washing machines to rise, ‘the U.S. does not need China as much as China needs the U.S.’”

— Barry Bannister, head of institutional equity strategy at Stifel

Hardball Strategy With China

It is fortunate for the current administration that the U.S. economy is performing extremely well. Corporate profits were projected to increase by more than 20 percent for two quarters in a row this year, yielding the best consecutive performance since 2010. Unemployment is at an 18-year low, and wages are starting to pick up. GDP growth hit 4.1 percent for the second quarter of 2018, reflecting the fastest pace in four years. All of this gives Trump the advantage to negotiate with other nations from a position of strength.

On the other side of the bargaining table, China, Europe and Japan are all experiencing slowing growth. China is particularly vulnerable because the country exports three times more goods to the U.S. than the U.S. sends to China (measured in dollars). Given its $280 billion trade surplus with the U.S., China has much more to lose in the current trade dispute.

While a trade war could escalate to the point of slowing global growth and inhibiting confidence among businesses and investors worldwide, many Wall Street analysts believe that Trump’s tariff strategy to position the U.S. ahead of trade deficits will be successful.

Global Trade Response

Although China may be the primary trade partner in Trump’s crosshairs, his initial proposal called for global tariffs across the board pending new agreements negotiated with individual trade partners. While the knee-jerk reaction by some countries has been to retaliate with their own import tariffs, this may not be the most prudent response from both a political and financial perspective. In fact, smaller countries are likely to feel the most impact, as they lack the bargaining power of, for example, 500 million consumers in the European Union (EU).

To wit, President Trump and European Commission chief Jean-Claude Juncker announced an agreement to stay tariffs until they negotiate a more mutually amenable trade agreement. This follows a heated exchange over Trump’s initial steel and aluminum tariffs and the EU’s threat for subsequent countermeasures.

Although Canada is one of the more vulnerable smaller economies, it has already responded with 25 percent tariffs on $12 billion in U.S. imports. One analyst has suggested that Canada could take the extreme step of barring trade in banking and insurance services, restricting foreign investments or energy exports, or denying U.S. patent protection for intellectual property.

Mexico is actually in a stronger walk-away position than Canada, as its foreign investment is growing due to separate trade deals with countries that have expanded export markets in recent years.

South Korea has already accepted restricted import quotas in order to avoid steel tariffs and modified its bilateral trade deal with U.S.-placed quotas on Korean cars.

Several emerging-market countries play an active role in global supply chains and are most impacted by the tariffs on imports from China. Consequently, collective export volumes year-to-date are down by about 6 percent from a year ago.

Impact on Investment Markets

Despite turbulence in the global trade market, U.S. stocks have remained resilient. There is currently $3.4 trillion invested in S&P 500 index funds across a myriad of 401(k) plans, IRAs, mutual funds and ETFs.

Should Trump’s trade gambit prove successful, especially with China and/or the EU, enhanced trade agreements would be a boon for the already booming health of U.S. companies, with residual benefits for investors. In the meantime, much of U.S. growth is driven by sectors such as health care, which are less impacted by trade disputes.

Final Thoughts

Trade wars involving significant tariffs can produce several trickle impacts. First, higher costs are passed on to consumers, which can cause higher overall inflation. Higher prices also can bring about reduced demand for goods, which can lead to lower production and job losses. Ultimately, higher tariffs on U.S. imports and retaliatory tariffs on exports could slow global growth.

However, that’s a worst-case scenario. Trump is using America’s economic dominance as a tool to threaten tariffs in order to negotiate trade agreements that position the U.S. for more expansive growth in the future. Should his strategy pay off, U.S. investors are well-positioned to benefit.