Trying to Make Sense of “Phase 1”

By December 13, 2019Weekly TGIF

There is apparently a trade deal with China. It still remains unclear what’s in it. That’s sort of been how this whole trade war has gone since tariffs began September of last year. The process has been so bumpy, and Market reaction has too. The stakes are high. Neither country wants to make significant concessions. Both sides have been culpable of playing games. This is our interpretation of what happened and where it might be headed.

China definitely made a move that backfired in October, pushing for an immediate rollback on existing tariffs in addition to agreeing not to impose new duties as part of their effort to seek what they called a “balanced agreement.” The Chinese calculated that President Trump was under pressure to get a deal done with impeachment proceedings and the 2020 election campaign had begun. The result was, talks broke down and tariffs stayed on, with another round set to increase December 15th. That’s Sunday. Talks picked up again, with the looming deadline fast approaching. The deadline has been averted, for now.

The Deal

China agreed to purchase $200 Billion worth of US goods and services over a period of two years, which includes $40 Billion of agricultural goods, with an attempt of $50 Billion. China also agreed not to impose tariffs on US goods. In exchange, the US is rolling back 50% of existing tariffs. As we understand it, this means that there will be no December tariffs, the 25% tariffs on $250 Billion will remain as is, and the 15% tariffs on $130 Billion worth of goods will now be 7.5%. The December tariffs would have hit imports of high demand Chinese-made goods ahead of the holidays. That includes smartphones, toys and consumer electronics.

This was new: Chinese leaders held a press conference to confirm the deal, but provided very little details. Our sources say the Chinese are sensitive to the perception that Trump is bullying them into making concessions. Perhaps that’s why they held a press conference themselves, to try to negotiate in public, stealing a tactic from the American President.

Now what?

Phase 2 talks are said to begin immediately. The thing is, “Phase 1” was the easy stuff in what is expected to be a long trade war, perhaps like a multi-decade Cold War on Trade. China needed to purchase pork and soybeans, and Trump needed to deliver wins for American farmers who have supported the President, but have been feeling economic pain. Both sides benefitted from the removal of tariff threats. Apparently, China made specific commitments on intellectual property, including counterfeiting, patent and trademark issues. These intellectual-property commitments will reportedly be announced later. They might not happen at all.

This Phase 1 deal does nothing to address the longer-term structural and strategic issues, other than prove that the two nations can, in fact, come to terms on something. This suggests the cold technology war will continue, regardless of what happens with the 2020 election. China knows this and wants to become less dependent on American technology. China wants to be the innovator of the century. The US wants to keep this title. This will have ramifications beyond existing technology supply chains and will spill over to other countries that might be forced to choose between China, which offers economic benefits and the US, which offers geopolitical benefits. The role of power in the world is the prize.

Market Reaction

This Phase 1 deal was basically the minimum the Market expected. Companies have been holding back on capital expenditures because of the uncertainty of trade and tariffs. That will certainly have an impact on earnings and the US economy next year. The Stock Market went haywire this week, exploding higher on rumors then declining with confusion and disappointment. Both the DOW and S&P closed flat heading to the weekend. The big question for investors now is whether this Trade deal was already priced in, which could send stocks lower, or perhaps the uncertainty is starting to be priced out, which could send them beyond these all-time highs. Stay tuned.

Have a nice weekend. We’ll be back, dark and early on Monday.

Mike

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