SINGAPORE (July 30): When is a trade war not a trade war? When it’s a trade battle. Or a trade spat. Some have even called it a trade tiff, which makes it sound no more serious than a domestic disagreement, like a couple arguing over whose turn it is to do the dishes. 

Whatever label you choose, it is clear that tensions have entered a new and potentially dangerous phase. Up to July 6, one could still argue that all the talk about tariffs was merely a bargaining chip to get the other side to the negotiating table. But now the threats have become reality, with the US and China levying tariffs on US$34 billion ($46.5 billion) worth of each other’s goods, and threats to tax practically all imports from the two countries.

Interestingly, stock markets around the world have responded very differently. China’s equity markets have been hurt badly, with the MSCI China 50 A share index down about 20% in US dollar terms since March 1 (see chart).

Europe’s shares are at roughly where they were on March 1, although we can see the negative impact of tariff talks in June as US President Donald Trump opened up another front with a dispute on European automotive tariffs. US shares, on the other hand, are in fact higher than they were at the beginning of March, owing to a strong domestic economy and lower exposure to international trade flows, although they, too, showed a slight dip, owing to nervousness about trade in the first half of June.

The obvious question then is how we should be responding as investors from here on. Do we expect the real-world impact of the trade war to be more or less serious than what is currently already priced into the market? If we see more negative surprises on the horizon, we should be reducing our exposure to equities and holding some cash in preparation for a further drop. Conversely, if we expect tariffs to be not as bad as originally assumed, we should stay invested or maybe even buy into this dip. 

This is of course fundamentally unknowable, not only because geopolitical events are especially difficult to predict in the Trump era, but because there is no surefire way to predict how markets will react even if we predicted the outcome correctly. Investor reactions are never entirely amenable to rational analysis until after the fact, where they suddenly become obvious with hindsight (by which time it is too late). 

So, nobody really knows what will happen, but here is my point of view. Trump said “trade wars are good, and easy to win”, and everyone laughed at him for being a fool, because, of course, everyone knows that trade wars are a lose-lose situation for all parties. 

Everyone was wrong. From Trump’s perspective, it is quite easy to see how he is winning the trade war with China. He has a higher value of imports to target. His domestic economy is strong, while China has to walk a fine line to avoid a hard landing from its deleveraging efforts. For a president that so often takes credit for the performance of the stock market, Trump must be gratified that US stocks are up while China’s markets are hurting badly. The tariffs may indeed be lose-lose from an economic standpoint, but once political priorities are taken into account, Trump has every incentive to press China for concessions in order to play to his base and stay in power. China has few credible levers that will hurt him enough to dissuade him from doing so, without also hurting itself even more.

To be clear, this power disparity is a reassuring thing for world trade, because it actually reduces the probability of a trade war. China, being weaker, has no clear path to dissuade Trump and therefore has to focus on minimising damage to itself. It can most readily do this by appeasing Trump (in as face-saving a way as possible), as long as it believes Trump will not attack it further after his first initial victory. This is a reasonable assumption, because Trump’s key priority is to get a win to crow about to his supporters. He is not interested in escalating the trade war merely for the sake of doing so — more tariffs would hurt the US as well, and he needs Chinese President Xi Jinping’s help for his other policy priorities, including North Korea. Therefore, if China hands him an early victory, it is not in his interests to continue escalating further.

Put in game theoretic terms, the most stable Nash equilibrium is for China to appease and Trump to cease escalation — in that state, no party has an incentive to deviate from their chosen strategies, not even Trump, as they would be poorer off if they deviated. The conflict would be much riskier if the two combatants were equally matched, but in this case it is not.

The big caveat of course is that this assumes that both states and leaders are rational actors with stable preferences, which China generally is, but Trump sometimes is not. There is also no obvious path right now for China to back down in a face-saving manner — in part, these are conditions that Trump needs to create. If both parties are successful in negotiating this, serious economic damage can be averted. My sense is that there is still a chance for them to come to an agreement, with China giving up more than the US, and therefore I believe there is some upside compared with current market levels, although we should expect many ups and downs before the issue is actually settled.

On the whole, it does not seem appropriate to reduce equity exposure right now, especially in Asia, where valuations have fallen to undemanding levels. Volatility will surely come in the next six months — the best response is to diversify globally, stay invested and let the conflict run its course. 


Herbert Lian is a financial adviser representative at IPP Financial Advisers Pte Ltd. The views expressed here are solely those of the author in his private capacity. This article should not be regarded as professional investment advice or as a recommendation regarding any particular investment.