Will US-China Trade War Crash the Stock Market?

Photo credit: 123RF/Jenny Lipets

Alibaba postponed their Hong Kong listing.

USA farmers are struggling badly because they are losing a huge customer (China).

Companies have to raise prices to defray higher raw material costs.

The Hong Kong and China stock market took beatings.

Investors lost money.

All these happened because of the trade war between United States and China.

How should we think about it? What is my economic analysis?

Let me offer my two cents. It is my perspective and nothing is, of course, truthful. 

Donald Trump’s Game

Donald Trump wanted low interest rates but he could not get it from Jerome Powell who is the chair of the Federal Reserve. Being a strategist, he knew he had to force Jerome Powell’s hands. Donald Trump proceeded to raise tariffs on China and it caused some slowdown concerns around different sectors of the economy.

I disagreed because as I observed the earnings of consumer-related companies, the US economy is still going very strong. Nonetheless, on 1 August 2019, the Federal Reserve cut interest rate by a quarter-percentage point, bringing the target range between 2 percent and 2.25 percent.

See, Jerome Powell was being forced because of the increased tariffs. He wanted to protect the economy by cutting rates as an insurance against recession. It’s his responsibility as Chair of the Federal Reserve.

A few weeks later, President Donald Trump continued to pressure Jerome Powell to cut interest rates further.

Trump is playing a very smart game here. Since he cannot get what he wants, he utilised other methods (eg, raise tariffs) to get his interest rate cut.  Now, Donald Trump is very interested in getting himself re-elected in 2020. In consumers’ mind, nothing matters more than the economy.

My thinking is he would force another round of interest rate cut and maintain the status quo on the trade war. I believe it is very easy for Trump to resolve the trade war before or during his re-election bid. The China side has given concessions. Trump is squeezing China’s side for more and keeping the constant pressure. Even if Trump accepts the current deal, how is it not a win for the American economy already?

That would lift the uncertainty off the economy immediately. The stock market would rally. Americans would feel happy. But remember something? It was because of the trade war that caused interest rates to be cut.

So now, you have a case where the trade war is resolved and interest rates is lower than where it first started during a period of trade war. How can the economy not roar back to life? This would push Donald Trump towards securing his re-election in 2020.

Is There a Crisis Coming Soon?

I have never spent too much time wondering whether a crisis is about to happen or not. I will just keep compounding by allocating my money to the best companies available in key markets. This involves a lot of fact finding with investors, management, suppliers and employees.

Throughout the history of mankind, money is always allocated to opportunities with the highest Return on Investment (ROI). That is the natural order of capitalism.

Every individual would compare across various investment choices then decide on how to invest.

For example, if your current bank is giving you 2% fixed deposit rates that’s almost risk-free, would you buy stocks and hope to make 2% only? The answer is no.

You would expect to make 15-20% returns. You will make a comparison in your head and say, “I am taking on some form of risk by investing in stocks, so I definitely have to make more than 2%.“

I would tell all of my friends that you need to compare and contrast to achieve better returns outcome for your portfolio. Why would you a REIT that is giving you 4.5% yield with the risk of losing tenants during a recession versus buying VICOM that’s giving 5% and it is recession-proof? In our Dividend Income Mastery, we advocate investing in REITs which it meets your required return.

Back to this topic… 

Stocks have to give you more returns! It’s not entirely risk free but you will do well when you know what you are doing.

Now, the fed funds are at 2% – 2.25%. When the interest rates are low, worldwide bond yield will drop too.

When you invest in bonds and fixed deposits, you do not have ownership of any companies. To keep it simply, it is like a loan agreement with pre-agreed returns.

Very simple and straightforward to understand.

Stocks, on other hand, represents ownership of a company. When you buy a share of Google, you’re a shareholder of Google. In its latest Q1 2019 results, Google’s earnings went up by 15%. Would it be safe to say your business is worth 15% more since it is earning 15% more than last year? I think, basing on earnings alone, it is a safe statement to say.

Compare the returns of bonds and fixed deposits against some stocks that are growing their earnings at 15% per year, which one is a better investment?

Between 2% and 15%, it is quite a large gap.

In the past, when interest rates are around 6% and stocks are giving 10% return, the gap is 4% only. Are stocks enticing? Definitely less enticing than today.

In a favourable scenario like today, why would the stock market crash? And if stock market crash, where would the money flow? Back to cash? Back to bonds or fixed deposits? How is it possible when businesses are growing their earnings by 15% and above?

Cash is cash, it does not grow.

Bonds and fixed deposits do not grow beyond their initial investment and the interest payments received.

Stocks/shares are different. When selected correctly, you are buying into companies whose earnings could grow by 15%, 20%, 40% or more! The value of your shares are going to grow.

We are in an unique situation where we enjoy unprecedented low interest rates and this is why money can be borrowed at very cheaply and they have to flow to somewhere to receive higher returns. Likewise, for any investors, they can search for suitable investments and I believe there is no other attractive investments such as stocks today.

Conclusion

I believe there are too many noise out aka the daily ebbs and flows. Keeping our eyes on the bigger picture, we need to know the players in this game in order to position ourselves correctly. The convenient kind of thinking that a stock crisis happens every 9 years may not be accurate anymore.

What I see is a continuous growth in the stock market supported by increased earnings.

I don’t believe US-China trade war will crash the stock market.