Third Quarter 2018

Over the past few years, financial markets have benefited from continuous global economic growth. As a result, major equity markets have delivered positive returns and credit markets are witnessing a gradual return to interest rate normality. Unfortunately, rising trade tensions are threatening this otherwise positive environment.

Free trade is positive for economies throughout the world. In theory, goods and services produced in the lowest cost regions are sold into the markets where they are most valued, benefiting all concerned. In practice, this has led to significant job displacement in the developed world, giving rise to populist governments whose actions benefit locally rather than globally.

While free trade is attractive in theory, it is rarely practiced in its purest form. Most developed countries will protect certain industries, and be denied access to other country’s markets. For example, Canada protects its airline, telecom and dairy industries. The United States protects its own dairy, steel and hardwood lumber industries from importers. China denies access to whole swaths of its large and growing domestic economy to practically all of its trading partners.

While there is no perfect free trade in practice, global growth depends on trying to make an imperfect global trading system better, not worse. The political instinct in some countries is to protect locally and disengage internationally, which could lead to a deteriorated economic environment.

The current global trade tensions have two major flashpoints. The first encompasses negotiations between the U.S. and its much smaller neighbouring economies – Canada and Mexico. These negotiations have resulted in a new deal called the USMCA (United States Mexico Canada Agreement). This new arrangement has been trumpeted loudly as a U.S. victory, while in reality it is only marginally different than the NAFTA agreement that superseded it.

The second relates to U.S. trade negotiations with China. There is currently a significant trade imbalance between China and the U.S., with the Americans exporting only US$ 130 billion to China annually, while importing over US$ 500 billion in goods from that country. While trade imbalances are not necessarily bad, there are elements to the trading arrangement between these two global economic giants that are deemed unfair. The U.S. is not wrong to complain about the Chinese appropriation of intellectual property and is justly frustrated by continually being denied access to the vast and growing Chinese market. The United States has taken on the role of the aggressor, placing tariffs on hundreds of billions of Chinese imports. The leadership in China feels that they have no choice but to retaliate.

It is hard to imagine that these tactics will bring the two sides together amicably. Most likely, they will lead to escalating retaliatory tariffs that could have a damaging effect on the global economy over the longer term. Without a doubt, this current environment does promote uncertainty. With this tension lingering over equity markets, we believe caution is warranted within client portfolios. Strategically, we will be carrying higher cash positions through the balance of the year or until we see a longer term resolution of this impasse.



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