Does Focusing on the Trade War Miss The Point?

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If you listen to stock traders, a lot of their focus is inevitably on the US-China trade war. Any rumor that floats the idea that trade relations are improving between the two nations moves stocks up a bit. And any rumor to the contrary punches them back down.

But does it miss the point?

If we look at the broader picture, conflict between the US and China is going to be with us for a very long time. It isn’t going to be resolved based on a trade resolution or based on what policymakers happen to be in place. It goes beyond basic disagreements over trade balances.

There are broader issues at play with respect to market competition, militarism, market access, property rights, intellectual property, cybersecurity, and so on, that are symptomatic of a deeper underlying conflict.

It can involve capital, too. For example, the US relies heavily on China to help fund its deficits and keep borrowing costs low because of the way China purchases US Treasury bonds. On all of these matters, both nations are at odds even if the main headline right now is about trade. This range of issues is insufficiently appreciated.

Much of it is cultural. The US is a nation of individuals, where the basis is to largely govern based on what’s best for the individual (for example, the protection of individual liberty and freedom). China predominantly makes decisions based on what’s perceived to be best for the state as a whole, thinking of the country and its citizens as a large family. Accordingly, there is a stark contrast in the different ways, beliefs, and attitudes of handling certain situations.

For example, the Chinese government will regulate celebrity gossip and prohibit hip hop songs with crass lyrics and hip hop artists who feature tattoos, believing those things don’t promote the right values that are in the best interests of the country. In the US, and most of “western” society, most would find such measures objectionable in that those shouldn’t be under the purview of a central government.

When one power rises to challenge another, as China is doing with the US, there tends to be conflict in various forms. That isn’t going to go away based on some new ostensible cooperation or thawing of trade relations. Trade can be handled and they can get past that. But other issues are more endemic.

Beyond the Trade War: Risks for Financial Markets

All of these risks very much have material implications for financial markets beyond the trade war itself.

Even though certain types of risk events happen infrequently or haven’t happened in our lifetimes, it’s imprudent to not heed caution to them. Those are always certain things you can’t anticipate and you need to be as immune as possible to them. You can’t predict some major geopolitical events that can cause particular markets to shift 20% or more in a single day. For example:

July 30, 1914; February 1, 1917; September 17, 1939; December 7, 1941; June 25, 1950; December 22, 1973; November 4, 1979; January 17, 1991; September 11, 2001.

When you look back on history over the centuries and millennia, when one major power challenges another you either get war – as in a legitimate shooting war, not the co-opted term for the trade dispute – because one country wants to maintain power while the challenging country wants to increase its own influence. Or you get exceptionable measures to avoid those every time.

It is very important to recognize broader geopolitical shifts and to be able to anticipate what kind of residual effects these could have on assets and the economy. For traders, this means neutralizing what these effects could have on your portfolio by stress testing how it would have done throughout history. If you think the latest volatility in stocks, commodities, and other financial markets has been high, markets can easily do many multiples of that (5x, 10x, or more). They’ve done it in the past.

Traders should think about their diversification and avoid being excessively exposed to potential risk events that they have no control over.