Quarterly earnings reports have diverged from the standard (and usually boring) overviews of the balance sheet, to talk of how the company is being hit by – and how it is preparing for – a lengthy trade war with China, and more recently, Mexico. There is worry across most board rooms, as executives scramble to re-evaluate their supply chains, play out alternative scenarios and assess the potential risks.
While politicians like to appear strong, we underestimate the strength of China at our own peril. In reality, we need them as much as they need us. An article in World Policy Journal noted that “China’s growth is something that Europe and the Americas are reluctant to accept: China’s innovation engine and status as a serious competitor is on the rise.”
It is fairly simple to rearrange one’s supply chain to find new sources for the manufacture of cheap commodity goods – but China’s manufacturing sector is high-tech, sophisticated and far more advanced than we give it credit for, and they rank second in the world in high-tech manufacturing, only very slightly below the US. In short – a trade war with China is not easily winnable, and is very likely to do harm to American businesses, consumers and investors.
Impact on small to midsize business
Larger US-based corporations may be able to absorb the additional costs they are facing due to the tariffs, and are more likely to be able to devote resources to the supply chain engineering that has already become prevalent.
But those worries are not limited to Wall Street – small and midsize businesses are feeling the pressure as well, especially in the retail, agricultural and manufacturing sectors, and without the right preparation, some may not survive. Smaller and midsize corporations with $10M or less in annual revenues are more likely to feel an outsized pinch, and less able to roll with the punches. And finally, at the consumer level, individuals are starting to realize they too, may have to re-evaluate their own financial plans, spending patterns and investments as a result.
Smaller companies are not ready for a trade war, and many were waiting to re-evaluate their supply chains and inventory levels under the belief that the disputes would be resolved quickly. The National Retail Federation notes that tariffs tend to undermine growth in the retail sector, and one of the largest and fastest-growing retailers in the country – Dollar Tree – has already warned that tariffs on Chinese imports will affect their business as well as their shoppers. Walmart has echoed the same sentiment, saying that additional tariffs will mean higher prices for US consumers.
How companies can respond
The stated political goal of tariffs and trade wars are to attempt to force other countries to alter their industrial, economic and trade policies, while encouraging companies to re-shore manufacturing to the United States. From a business perspective, this is mostly impractical and often impossible. Manufacturing often involves multiple parts sourced from a deep supply chain across many countries, and disrupting existing supply relationships can be inherently dangerous to any business. Businesses are likely to respond in one of two ways: Keep existing relationships despite tariffs, or find new relationships, likely in emerging locations such as Vietnam or India. In some cases, companies may either (1) decide to stay with existing relationships even with a 25 percent tariff, because they have come to trust their Chinese supplier and changing the relationship could cause a significant disruption to sourcing and may even cause major delays as a new supplier may have to re-tool to get up to speed; or (2) look to new suppliers in alternate locations.
A less likely, but often efficient option is to attempt to drive additional value out of the supply chain by keeping the current supply chain intact, but re-visiting protocols with an eye towards greater efficiency, reducing inventory levels and therefore costs, and bringing in more analytics to better understand things like customer trends so as to better anticipate demand.
How individuals can respond
The trade war doesn’t just impact how corporations think about how they operate and invest, it will impact how individuals do as well.
According to the New York Federal Reserve, tariffs which have already been imposed on Chinese imports will cost American families an average of about $800 a year. Now is a good time for conservative investing. Tariffs translate to an increase in material costs for corporations. If those corporations absorb the added costs, profits will decrease; if they pass the costs onto the consumer, market share will decrease. Either way, share price is going to take a hit. As a result, investments in companies most likely to bear the brunt of tariffs, such manufacturers using steel, or retailers relying heavily on Chinese imports, would not be advisable.
Because trade wars are inflationary, one likely result would be the Federal Reserve raising interest rates to counter that inflationary trend. This would be bad news for the housing and construction industries, but somewhat better news for those interested in simply putting money into interest-bearing accounts. On the other hand, it will be more expensive to borrow money, which may negatively impact mortgages, home equity lines of credit, or business loans.
At least in the short term, markets will be volatile. International stocks may become a lot more attractive, keeping in mind that the trade war is playing out to be less of an all-out global trade war (everyone against everyone) and more of a US-versus-everyone-else trade war. More secure investments and ETFs for example, which avoid industries that will be most susceptible to tariffs (su8ch as semiconductors, electronics, agriculture, and steel-consuming manufacturers) would be in order.
In day-to-day consumer life, get ready for somewhat higher prices, which may dig into your ability to invest or save. This will be a good time to take a close look at your personal finances and spending habits, as well as your personal investment portfolio.