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The Ghost of Smoot-Hawley: Trade Woes Spook Stocks

By John Persinos on March 14, 2018

To understand the stock market’s steep losses today, let’s turn to game theory.

Protectionists seem to think that trade is a zero-sum game, in which each participant’s gain or loss is balanced by the losses or gains of the other participants. It’s not.

The rise in living standards around the globe after World War II is due in large part to the expansion of free trade. That’s a positive-sum game, in which the sum of positives and negatives (wins and losses) is positive.

Trade wars, on the other hand, are a negative-sum game. All sides lose. Wall Street is waking up to the lose-lose proposition of protectionism. You should, too.

The three main indices sharply fell on Wednesday, as investors fretted about proliferating barriers to trade. The Dow Jones Industrial Average dropped 338 points at its session low. The Dow closed below the 25,000 level today.

Investors are haunted by the specter of the 1930 Smoot-Hawley Tariff Act. Enacted under the Hoover administration, Smoot-Hawley raised U.S. tariffs on over 20,000 imported goods. The tariffs collapsed the banking system and helped push the U.S. and the global economy into a decade-long depression. This history lesson is not lost on traders.

The financial community understands that tearing up the rules on which international trade is based will not make America great again. Nonetheless, U.S. government intervention is becoming more aggressive. Investors initially thought President Trump was bluffing with his tough trade talk. He wasn’t.

German Chancellor Angela Merkel is bracing for an all-out trade war with the U.S. Germany is the growth engine on the Continent. A rift with China is one thing, but a possible trade war with Germany makes investors very nervous.

Merkel said on Wednesday that the European Union must be prepared to respond decisively to the unilateral imposition of trade tariffs by the U.S. Merkel is considered the de facto leader of Europe; her remarks carry considerable clout.

It’s not just tariffs. The brewing trade war is affecting corporate mega-deals.

The Trump administration stepped in this week to block chipmaker Broadcom (NSDQ: AVGO) from buying rival QUALCOMM (NSDQ: QCOM). The action weighed on the tech sector Tuesday and Wednesday.

Broadcom is based in Singapore; QUALCOMM in San Diego. The White House expressed concern that a Broadcom-QUALCOMM merger would tilt the semiconductor playing field in favor of China, which the Trump administration is increasingly holding up as the international boogeyman.

Washington’s action this week to block the $117 billion marriage of the two chipmakers is exacerbating geopolitical tensions. Broadcom isn’t based in China. However, China and its Asian neighbor Singapore have nurtured close relations. The fear is that China exerts growing influence on Singapore and the region, which would give the Middle Kingdom too much sway over the combined companies.

Whether these worries are justified or not, tech investors are skittish. They see the intervention of Uncle Sam in the proposed merger as a sign that perhaps other deals will get scuttled in the name of an “America First” policy.

Tech investors have been on a sugar high in recent weeks because of tax cuts. Now, they’re crashing from that high, as they belatedly price in the risks of government meddling.

Steel and aluminum tariffs signed by the president last week are aimed at China. However, most of America’s steel comes from the European Union, Canada, South Korea, and Mexico.

The chart tells the story. It depicts U.S. imports of steel and aluminum, by country (in billions of U.S. dollars). The numbers come from the Peterson Institute for International Economics.

Notice how China, our country’s intended target, is way down the list.

Canada and the 28-member European Union have vowed retaliation against U.S. goods. These countries are America’s long-standing friends. Rancor between the U.S. and its traditional Western allies would benefit at least one country: Russia.

At the same time, blue-chip American manufacturers such as Boeing (NYSE: BA) that rely on steel and aluminum would see their costs go up. Boeing is a Dow component.

Overseas customers have threatened to retaliate for the tariffs by purchasing airplanes from Boeing’s rivals. Workers at the aircraft maker’s factories would be the victims. The Pentagon would get hit, too. Our military relies on Boeing combat jets and helicopters.

Trade war fears have been clobbering Boeing stock. BA shares fell 2.48% today.

Consumers cut back…

Clouds emerged today over the U.S. economy as well. Consumers appear to be getting stingy.

Investors keep a close watch on consumer spending. With good reason. In the U.S., consumer spending accounts for about 70% of gross domestic product (GDP), providing the growth engine that has pulled the country’s economy out of most post-war economic downturns. Shopping is the national pastime.

The U.S. Commerce Department reported on Wednesday that retail sales fell 0.1% in February compared to January. It was the first time since April 2012 that retail sales have slipped for three straight months. Analysts had expected retail sales to rise 0.3% in February.

The decline in retail sales last month suggests a slowdown in economic growth in the first quarter, as consumers reduce purchases of motor vehicles and other big-ticket items. In February, auto sales fell 0.9% after a similar drop in January. Rising interest rates could be dampening consumer enthusiasm.

The Fed has been raising rates gradually since December 2015. The central bank has planned three interest rate hikes this year, with the first hike expected at its March 20-21 meeting. As inflation heats up, odds are the Fed will raise rates at least four times this year. But the Fed also is concerned about asset inflation.

Fed Chair Jerome Powell may have a surprise in store for investors, by proving more hawkish than expected. Investors are getting worried that the Fed won’t stop at four. This fear, combined with the Trump administration’s mercantilism, sent stocks deeply into the red today.

Wednesday Market Wrap

  • DJIA: -1.00% or -248.91 points to close at 24,758.12
  • S&P 500: -0.57% or -15.83 points to close at 2,749.48
  • Nasdaq: -0.19% or -14.20 points to close at 7,496.81

Wednesday’s Big Gainers

Footwear maker posts strong earnings.

Camping retailer expands into South Dakota.

Analysts bullish on mortgage REIT.

Wednesday’s Big Decliners

Demand slumps for power engineering firm.

Retailer’s restructuring plan gets thumbs down.

Analysts skeptical of offshore energy firm’s convertible senior note offering.

Letters to the Editor

“The financial services sector looks appealing. Your thoughts?” — Gavin L.

Strong economic growth is a tailwind for financial services. Another positive for bank stocks is Trump’s determination to dismantle banking regulations, especially the Dodd–Frank Wall Street Reform and Consumer Protection Act.

It also bodes well for the industry that the president has chosen top banking executives for key positions in this administration. The massive tax cut bill is another gift for the industry. Banks tend to take fewer deductions than other corporations. The bill’s reduction in the top rate should prove a boon for banks.

Questions about which sectors are hottest? Send me an email:

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.


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