BMO's Douglas Porter urges plan sponsors to stay vigilant in their investments as the two top world economies battle for trade
As the US-China trade war escalates, Douglas Porter is preparing for a prolonged era of elevated US tariffs.
He cautions institutional investors to brace for a macro environment that’s likely to remain volatile, inflationary, and growth constrained. He believes high tariffs are here to stay, at least for the duration of Trump’s administration and even beyond. But as he warns, the damage done to China could end up being a hefty price.
“To me, a tariff over 100 per cent will in a matter of time basically shut down trade between the two,” said the chief economist at BMO Financial Group.
That kind of disruption could have profound consequences on global growth and by extension, institutional portfolios and pensions, he said.
“China is the number two supplier to the US after the European Union, it's very serious,” he said. “I can't imagine anyone importing anything at 100 per cent tariff. It's also tough to imagine anyone in China is importing anything from the US at an 84 per cent tariff. Clearly, this is not sustainable.”
Porter noted either country will have to back down or mutually reach an agreement to “at least tone it down a little bit.”
As for how we got here in the first place, Porter pointed to the root of the conflict, which was Trump’s obsession with trade deficits during his first term.
“He sees them as unequivocal bad and frankly, what we’re seeing in recent days makes what happened in 2018-19 look like a tea party. This is much more serious,” explained Porter, while highlighting that during Trump’s previous term, China was the clear target of protectionist policies.
This has institutional investors and pension funds alike ultimately questioning how to rebalance their portfolios, especially those with significant exposure to China and Asia-Pacific. And despite the market’s recent rally after Trump’s announcement to pause tariffs for 90 days, Porter believes they should be concerned. Particularly as US stocks fell back down almost four per cent Thursday as investors assessed the worsening trade war with China.
“I think that rally was really overdone,” he said, underscoring the bounce likely stemmed from technical factors, like a short squeeze, rather than any true confidence in the economic outlook. He also emphasized that markets have become hypersensitive to almost any utterance on the trade front, with prices reacting instantly and often irrationally.
“It suggested that perhaps the US administration can actually be swayed by what's going on in financial markets,” he said. But even with some easing elsewhere, he warns the average US tariff burden remains historically high. That’s why he urges portfolio managers and pension plan sponsors to stay vigilant.
“This is a very serious business to have the two largest economies in the world in a bare-knuckle brawl over trade,” he said, noting the IMF’s recent warnings about global growth risks tied solely to this US-China conflict.
“We really do have to scale back our expectations for returns in the years ahead,” emphasized Porter. “I wouldn't make any radical changes by any means. We’ve seen tremendous volatility even in the last few weeks or so. I think that just tells you that it's still very much a two-way trade in a lot of markets. It's not at all obvious where we’re ultimately going to settle out.”
For pension plans and long-term investors, his advice is to tread carefully, particularly in the equity market. He advocates for lower-beta, low-volatility strategies and an allocation tilt closer to home.
“Be towards the lower end of equity ranges… a little bit more low volatility in general.”
Alex Cousley, senior investment strategist for Asia-Pacific at Russell Investments, also agreed that caution is warranted but sees a longer-term value play for China.
“We still think that an allocation makes sense because valuations are cheap and Chinese corporates have been becoming a bit more focused on shareholder returns,” he said in a statement. “In the last twelve months, we have seen large Chinese corporates conducting buybacks. This is quite encouraging from a longer-term perspective.”
But Porter is less optimistic about China’s outlook.
“If you're looking at a medium to longer term, it’s really tough to be bullish on China,” he said, pointing to structural issues like demographics, a property sector in crisis, and increasing restrictions from other markets.
“Even if the trade war does simmer down and we get to a more manageable level of tariffs, the view is that China is going to be constrained by the US for a while,” he added.
Cousley agreed that some of the structural improvements in Chinese corporate governance offer glimmers of hope.
“The return on equity for Chinese indices has been playing catch-up to broader EM, which again, is good to see,” he said. But like Porter, he stopped short of recommending aggressive exposure.
So, what would signal an easing in tensions? Porter believes markets will see the signs.
“The signs will be right there in front of our face,” he said. “I’d be looking at a point where the Trump administration declares some kind of mild victory on the trade front. Until they seem somewhat satisfied with what they've done, I'd be very cautious.”
