Handicapping the Worst Case Scenario By: Gabriel PotterMBA, AIFA® 2017.07.03

There has been a strange dichotomy over the past several months.  The market keeps hitting all time highs on positive earnings, low unemployment and the expectation for a continuing stable economic environment.  However, Washington DC keeps floating out proposals with the potential to drastically transform the business environment.  It’s true; some of the proposals have the potential to improve US growth rates, such as lowering corporate tax rates and repatriating overseas cash.  However, there have been at least an equal number of policy proposals with the potential to whipsaw the slow-and-steady US economy into recessionary territory.  Last week, the administration floated the possibility of a 20% tariff on Chinese steel, with the possibility to expand to other imports. 

Let’s ignore the potential for a trade war and assume the tariff is implemented without international retaliation.  Let’s also ignore the possibility the steel tariff expands into other goods from China or to other trading partners.   Who would benefit from such an action? The administration may hope US steel producers will account for a higher proportion of steel purchased for use in the US.  However, US producers won’t produce as much steel at the price our consumers would have originally purchased it at.  Additional costs mean fewer projects are economically viable wherever steel is a raw material (like car manufacturers), so total US GDP shrinks even if US steel producers directly benefit.  Moreover, impediments to trade and additional costs will decrease the total global consumption of steel – that’s just basic supply and demand.  In other words, both US and International combined production and consumption should both slow down from the tariff.

According to news reports, no final decision has been made, but could happen this week.  If the tariff comes to fruition, the effect will, at a minimum, slow down the rate of economic growth.  The markets are supposed to be looking forward so the only presumption we can make is investors do not take this threat seriously.  It’s all political bluster; nothing bad has actually happened yet.  To the market optimists’ credit, there have not been any material changes to the engine of the economy over the past few months.  The broad sweeping policy changes have not materialized at all.  It has all been bluster, with no real effect thus far.  We have no magic ability to rate the odds of policy outcomes, and pessimistic scenarios may in fact be deeply unlikely.  However, we don’t want to simply turn a blind eye to the potential danger.

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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