Trade freedom has been dominating the headlines and adding to the growing economic risks and market volatility. Trump’s tariffs on steel and aluminium imports have prompted fears of a trade war, albeit with a low probability and with some comfort offered with the exemption clauses. This does, however, remind us that negotiating with the US is difficult and that NAFTA negotiations have yet to be resolved. A more important and difficult issue is that of intellectual property rights in relation to China. For now, markets seem to be looking through the bravado because it is mutually beneficial for all sides to avoid a trade war which would negatively impact global economic growth prospects. This week we quantify trade freedoms to validate that seemingly prosaic position.
Using data from The Heritage Foundation, we see there have been notable reductions in trade barriers across the world over the past twenty or so years. Figure 1 highlights the Trade Freedom Index – for the world and four major economies. The Index is a composite measure of the absence of tariff and non-tariff barriers that affect imports and exports of goods and services. Trade freedom for the world has improved from under 60 per cent in 1995 to just under 80 per cent in 2018. The US along with Canada and Germany are close to 90% on the trade freedom score. In the case of China, there has been significant improvement from 20 per cent in 1995 to over 70 per cent in the latest measure. The rhetoric really does seem to be misplaced.
If Trump wants to bash China, maybe he should be focusing on investment freedoms (constraints on the flow of investment capital, and financial freedom which is a measure of banking efficiency and independence from government control). Measures that track investment freedoms have deteriorated over the past twenty years. We suspect that common sense will eventually prevail and that the market is correct to heavily discount the prospect of a trade war and focus instead on the improving fundamentals.
The US economy created 313,000 new jobs in February which was the biggest gain since mid-2016 according to the non-farm payrolls, a key leading indicator of economic activity. Jobs created in January and December were revised up to 239,000 and 175,000 respectively. The unemployment rate was unchanged at 4.1% last month. Average hourly earnings, which had spooked market fear of heightened inflationary pressures, rose by just 2.6 per cent year-on-year in February down from 2.8 per cent in January (which in turn was revised down from 2.9%). The inflation scare seems to have passed, but growth remains buoyant with the University of Michigan Consumer Sentiment Indicator coming in strong and with the economy projected to grow by some 2.8% annualised in Q1 2018 from 2.6% in Q4 2017 according to the Atlanta Federal Reserve GDPNow model.
The economic fundamentals are important and we validate that in Figure 2 which highlights the close relationship between the S&P 5000 Index performance versus an economic composite indicator since 1998. The economic composite indicator is a blend of the Michigan Consumer Sentiment Index, the initial jobless claims and the CRB Spot Index. As George Michael might have said, “I think there's something you should know…”, we should be focussing on the fundamentals and discounting the rhetoric for now.
Brent Woyat, CIM, CMT
Investment Advisor, Portfolio Manager
Canaccord Genuity Wealth Management
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