U.S. and China Engage in a High Stakes Game of Poker - May 13, 2019

When two rivals are squaring off in a game of poker, one might ask, “Who will blink first? Who has the stronger hand? Who might be bluffing?

“You've got to know when to hold 'em. Know when to fold 'em,” Singer/songwriter Kenny Rogers said.

Where am I going with this?

On Sunday May 5, President Donald Trump surprised the public (and apparently, Chinese officials) when he tweeted he will raise tariffs from 10% to 25% on $200 billion in goods the U.S. imports from China. It became effective May 10.

The reason for the abrupt change in posture was summed up in a May 6 article in the Wall Street Journal – U.S. Trade Rep Says China ‘Reneging’ on Trade-Talk Commitments.

On Wednesday May 8, Reuters featured a story – Exclusive: China backtracked on almost all aspects of U.S. trade deal – sources. A May 3 cable received from Beijing “was riddled with reversals by China that undermined core U.S. demands, the sources told Reuters.”

Free trade vs fair trade

Major indexes have rallied sharply from last year’s low, in part, amid expectations the U.S. and China would come to terms on new trade platform. Last week’s drama cast doubt on that thesis.

Nonetheless, Chinese negotiators were back in Washington last week as scheduled, as officials hope to iron out differences.

But, did China bite off more than it can chew? Did it make a major miscalculation, gambling it could water down already agreed-upon terms?

The Wall Street Journal is no friend of protectionism. It advocates free trade and has quibbled with Trump’s tactics. However, an opinion piece last week took aim at China.

“Beijing has too often violated the global trading rules it agreed to and profits from. It steals trade secrets and intellectual property and handicaps foreign companies with punitive regulation. Chinese abuses have undermined political support for free trade in the U.S.”

According to Oxford Economics, China risks more economic damage than the U.S. if a deal isn’t reached.

2018 and today

Last year’s selloff was blamed on several factors. Tensions between China and the U.S., a slowing U.S. and global economy, and a Fed that was intent on raising interest rates.

Trade acrimony has resurfaced, but the Fed is no longer on rate-hike autopilot. U.S. growth has stabilized and may be accelerating. And, at least tentatively, we’re seeing more positive signs in the global economy.

Investor’s corner

Still, let’s recognize that last week’s spectacle took a modest toll on investor sentiment because the acrimony injected a new round of uncertainty into the economic outlook. Possible outcomes are skewed to the downside.

Plus, tariffs will translate into higher prices at home. Not surprisingly, investors reacted accordingly.

If negotiations break down, expect more short-term volatility. If we get an enforceable agreement, we’d likely see a positive impact on sentiment, at least over a short period.

Near term, investors are looking for encouraging words from either side.

While Trump has threatened additional levies, U.S. fundamentals remain favorable. Stay focused on the big picture.