Does China deserve “developing” nation status in the World Trade Organization?

David Nelson, CFA

With the Chicago Board Options Exchange SPX Volatility Index (VIX) living above 20 for more than 2 months I think it’s safe to say the glory days of low volatility and a market that seemed to know only one direction up; are a memory. While the fundamental underpinnings of the economy are still strong the news cycle continues to weigh on near term performance.

SPX Descending Triangle

Thursday was a classic bull move with a big down open followed by a 700-point positive swing in the Dow closing near the highs. Thursday followed through with some modest upside but of course later that night we learned the President was considering additional tariffs on China to the tune of $100 Billion.

World Trade Organization

There are strong arguments on both sides of the debate but it’s clear China has taken advantage of the system. As pointed out in Jamie Dimon’s letter to investors, China is currently listed as a developing nation in the World Trade Organization. Let that sink in for a second. China is the second most powerful country on the planet with an economy second to only ours. If current trends persist Bloomberg projects they will pass the U.S. within 10 years. How does China warrant the same status and perks as weaker members of the WTO?

Unfortunately, in the near term all of this plays out in real time as markets react to a news cycle that doesn’t let up. For now, Tariffs seem to be the weapon of choice and will likely cause continued sector rotation as winners and losers develop.

A better move would be to back incoming director of the National Economic Council Larry Kudlow’s idea of forming a “coalition of the willing.” Europe has just as many issues with China as we do, and partners would certainly give the administration leverage in any negotiations.

Make no mistake, there are risks to fighting back and continued escalation could damage the synchronized global growth story we’ve become accustomed to.

Defending the Status Quo

China is counting on our apathy and defense of the status quo. In the past we’ve opted to capitulate on trade for fear of disrupting current conditions. I suspect President Xi believes we are more concerned about losing what we have than willing to fight and defend our leadership role. From a geopolitical level, economic and yes even military China remains an adversary and with President Xi now in power for life a dynamic that isn’t likely to change anytime soon.

Earnings season

JPM EEG Q1 2018

This week marks the start of earnings season with reports from big banks starting on Friday. On the heels of the tax cuts estimates have moved dramatically higher in recent months. Add the fact that the Yield Curve continues to flatten despite hawkish comments from the Fed and there’s little margin for error in this week’s reports from the big banks. Expectations are high for Financials and likely important sector leaders like JP Morgan (JPM), Wells Fargo (WFC) and Citigroup (C) need to deliver.