Third Quarter 2019

In early 2018, U.S. President Donald Trump said “trade wars are good and easy to win”. With that, he kicked off the U.S.-China trade war, which has been escalating now for almost two years. Simultaneously, he bullied Canada and Mexico into a re-vamp of NAFTA (now called USMCA), which has yet to be ratified by U.S. Congress and may never become law. More recently, he launched a third front in the trade wars by taking on the Europeans in retaliation for the subsidization of Airbus aircraft. In this most recent circumstance, the U.S. has been allowed by the World Trade Organization (WTO) to place tariffs on American imports of Scotch whisky, French wine and Italian cheese. Mr. Trump recently hailed this as a “nice victory”.

The most important fight is with China, as the U.S. and China represent the two largest economies in the world. By the end of this year, 69% of goods shipped by the U.S. to China will be subject to tariffs averaging 26%. Going the other way, American tariffs on more than two-thirds of Chinese imports will be 24%, up from only 3% when this all started. The tariffs being charged are on goods valued in the hundreds of billions of dollars. Politically, Mr. Trump’s characterization of Chinese leader Xi Jinping as an “enemy” has further charged this aggressive atmosphere.

There is some legitimacy in the U.S. having become so assertive. For decades, China has helped itself to American intellectual property without paying for it. The WTO itself supports the American claim that Europe has unfairly subsidized Airbus. Here in Canada, it can be legitimately argued that local dairy farmers have been overly subsidized. The problem is not that there aren’t merits to each of these cases, but that the use of blunt force by the U.S. administration is causing measurable harm to global economic growth.

Trade concerns abound elsewhere. The United Kingdom seems determined to execute Brexit, no matter the negative short and medium term consequences. While the U.K. economy is only moderate in relative importance, it does add to the theme of trade conflict, and will cause economic disruption in the European Union. In Asia, stemming from a long-standing political dispute, the economic ties between Japan and South Korea have also become increasingly strained.

Generally speaking, free trade benefits the global economy. Goods are produced in the lowest cost jurisdictions and sold into the strongest markets, promoting the greatest economic efficiency (and profitability). Protectionism does the opposite. It forces production in higher cost areas, raises domestic purchase prices, and makes commerce less profitable.

On the back of the strong U.S. consumer, overall U.S. GDP has remained healthy, growing at an annualized rate of 2.5% through the first half of 2019. However, the industrial element of the economy, which over time has declined in overall importance to U.S. GDP, is slowing down. This is because businesses have become increasingly hesitant to commit large amounts of capital to new projects while the trade wars escalate. The longer the period of uncertainty, the more capital investment will suffer, in turn harming productivity, economic growth, and eventually, employment.

The uncertainty stemming from these multi-front trade wars and the unrestrained political leadership has also served to escalate market volatility. While the North American equity markets have advanced quite positively to date in 2019, it is increasingly evident that we are now in the midst of a global economic slowdown. While we are not predicting a recession at this time, we could eventually find ourselves in one if these trade issues are not resolved. We view this macro environment with concern, and do not discount the possibility of further economic harm. We will remain vigilant of how this could affect the companies that we are invested in, and will tread cautiously.

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