The Trump China Card
While the consensus of the clients I have talked to over the last week is still to position for the upside of Trumapanomics, there is a growing concern that Trump could turn his focus on China and play the “China Card”. This play is all about a policy to rebalance trade with China, reduce the $375 billion a year trade deficit with the US and subsequently increase US GDP. The administrations view is that a significant part of this deficit reflects Chinas unfair trade practices that the Trump policies can reverse, as described in a recent white paper written by their campaign 1:
“The elaborate web of unfair trade practices includes illegal export subsidies, the theft of intellectual property, the aforementioned currency manipulation, forced technology transfers and a widespread reliance upon both “sweat shop” labor and pollution havens. The People’s Republic of China also engages in the massive dumping of select products such as aluminum and steel below cost. It is currently dumping over 100 million tons of steel alone into global markets. China is hardly the only cheater in the world; it’s just the biggest….
A Trump Administration will not tolerate cheating by any nation. If America’s trading partners continue to cheat, a President Trump will use all available means to defend American workers and American manufacturing facilities from such cheating, including tariffs. “
So, why be concerned now? The Trump administration’s recent actions on immigration and the resulting turmoil and market sell-off has focused investors on other potential policy moves that could negatively affect the market. Clearly, a move against China could create a market sell-off that could dwarf the recent move. Further, the probably of a near term move on China is rising given that the administration has already followed through on the first four of their seven-point trade policy. More ominous is that the remaining 3 are all about China (see below)2
1. (done) Withdraw from the Trans-Pacific Partnership, which has not yet been ratified.
By executive order 1/23/17
2. (done) Appoint tough and smart trade negotiators to fight on behalf of American workers.
Appointed Peter Navarro, the author of “Death by China” director of National Trade Council
Named China critic, Robert Lighthizer, as the US trade representative
3. (done) Direct the Secretary of Commerce to identify every violation of trade agreements a foreign country is currently using to harm our workers, and also direct all appropriate agencies to use every tool under American and international law to end these abuses.
Named Wilbur Ross, another critic of China, as Commerce Secretary
4. (done) Tell NAFTA partners that we intend to immediately renegotiate the terms of that agreement to get a better deal for our workers. If they don’t agree to a renegotiation, we will submit notice that the U.S. intends to withdraw from the deal.
Executive order 1/23/17
5. Instruct the Treasury Secretary to label China a currency manipulator.
6. Instruct the U.S. Trade Representative to bring trade cases against China, both in this country and at the WTO. China's unfair subsidy behavior is prohibited by the terms of its entrance to the WTO.
7. Use every lawful presidential power to remedy trade disputes if China does not stop its illegal activities, including its theft of American trade secrets - including the application of tariffs consistent with Section 201 and 301 of the Trade Act of 1974 and Section 232 of the Trade Expansion Act of 1962.
Should investors be concerned, particularly given Trump’s statements about imposing a 45% tariff on China imports? The answer is of course yes, but, in my view, not enough to change their risk-on position that would benefit from positive Trumpanomics policies. For example, you would have missed the rally in bank equites after the administration’s move on Dodd-Frank that happened on Friday, and this is only the first step of many positive policy moves on this front. More importantly, the nuclear option, step 7, is unlikely to implemented in the near term. The most likely sequence of events of the China Card would be for Trump to implement steps 5 and 6 first. These steps, although potentially market negative, would not have any near-term impact on actual trade with China. Labeling China as currency manipulator only starts the clock ticking on negotiations that would take at least a year before anything happens such as tariffs. Bringing cases to the WTO, step 6, could take years before anything happens, if history is guide. According, the nuclear option, step 7, is unlikely before steps 5 and 6 get exhausted. That should push investors to continue to be risk-on at least over the next few months. Also, I would add to risk in the event of a negative market reaction to steps 5 and 6.
My recommended risk-on strategies for the next 100 days of the Trumpanomics continues to be:
Long regional banks
Long mortgage related companies, such mortgage insurers and home builders
Long chemical companies, metals and miners, and other companies that would benefit from lower energy prices
Buy payer swaptions or curve caps for higher rates & steeper curve
Having said that it would be prudent to add some put equity vole, against these positions, given the uncertainty surrounding Trump policies and current low level of implied vol. I favor buying July expiry 100/90% 6-month put spread on S&P at roughly $60, which is about a 3 to 1 net payout if market sells of a full 10%. Time decay should be something around 15-20% if nothing happens. And in that case, I would buy back the 90% OTM strike. My position on higher rates is also a potential hedge against a full blown trade war with China in which they would start selling their positions in US Treasuries.
Peter Navarro, Wilbur Ross, “ Scoring The Trump Economic Plan: Trade, Regulatory & Energy Policy Impacts” , September 2016
Donald Trump 7 Point Plan to Rebuild the American Economy by Fighting for Free Trade https://www.donaldjtrump.com/policies/trade