Despite a seemingly endless barrage of tough rhetoric and an escalating war of protectionist trade policies and tariffs, the U.S. trade deficit with China soared from $375 billion in 2017 to $419 billion in 2018 (a 12 percent increase), according to recent U.S. Census Bureau data. U.S. exports to China fell from $130 billion in 2017 to $120 billion in 2018, while over the same period imports from China increased from $505 billion to $540 billion.

The combination of trade war fears and uncertainty over Federal Reserve interest rate hikes played a large part in the recent Q4 market sell-off.  It’s only natural to ask, What will this mean for the markets going forward?

Trade Deficits Are Not Necessarily Bad

Sure, when the U.S. runs a trade deficit, it shows that our manufacturing sector isn’t what it once was, and deficits do serve to reduce our nation’s GDP. But deficits also typically indicate a healthy economy. With unemployment low, wages increasing and the recent tax cuts, Americans have more disposable income than residents of many other countries.

Additionally, declining revenues caused by the newly enacted Tax Cuts and Jobs Act is forcing the U.S. to borrow more, which increases the cost of the dollar. At the same time, money has been flooding into the perceived “safe haven” of U.S. dollars due to the increased economic uncertainty that the U.S.–China trade fight has created around the world. Together, these factors are bringing about a strengthening in the value of the dollar in relation to other currencies, which in turn makes the goods we import cheaper and the goods we export more expensive—   further widening the trade gap.

Trade data is also exceedingly difficult to measure with any true accuracy. Consider that a high-tech product from a U.S. company that’s designed, engineered and marketed in the U.S., using components from both U.S. and European manufacturers that are shipped to China solely for assembly, counts on the trade books as a Chinese export and a U.S. import if purchased by a U.S. consumer.

A Positive Outlook

While the uncertainty surrounding the ongoing U.S.–China trade dispute has caused volatility at home, the repercussions on emerging-market stocks (particularly China’s) have been far more severe. When the uncertainty is finally resolved, the MSCI Emerging Markets Index will fare particularly well—not only because China makes up nearly one-third of the index but also because growth there will contribute to an economic lift for other key emerging markets in the region. The Chinese stock market has already experienced a significant retrenchment from its June 2018 highs (a 30+ percent decline before recently recovering those losses). When things turn around, the upside opportunities in China may be far more pronounced than in the U.S.

The current administration may be intent on slashing the trade deficit, but without a massive move back toward a manufacturing economy—coupled with a significant drop in American consumer spending, which typically only happens mid-recession—it’s a nearly impossible goal. But since trade, by definition, is nothing more than a willing exchange between two parties who both benefit from the transaction, at the end of the day it doesn’t really matter whether we’re net buyers or sellers.

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