Quarterly Update

Jul. 2018

Garrett R. D'Alessandro, Chief Executive Officer | Jul. 2018

From the Desk of Garrett R. D’Alessandro, CFA, CAIA, AIF®

The United States has some difficult choices to make if it really wants to have both fair and free trade with China.

Fair Trade, Free Trade, or Trade War?

The United States has some difficult choices to make if it really wants to have both fair and free trade with China. The approach the U.S. has taken with the Chinese over the past 15 years—relying primarily on diplomacy and believing they will honor the principles governing international trade—has utterly failed. At this point, we believe the only open question is whether changing China’s behavior will require a trade war or if other forces can be brought to bear on Beijing.

The stakes are very high. The best minds in the world naturally gravitate toward countries that offer the greatest economic opportunities. Up until now, the U.S. has attracted the majority of those minds. However, this will change if the U.S. sees its economic prosperity continually eroded over the next five to 10 years.

We know where China stands. It wants to achieve economic domination over the U.S. by 2025 and has gone into hyper-drive with aggressive and unfair trade practices that include theft of American intellectual property, fraudulent reproduction of our goods, economic espionage, government subsidization of Chinese companies, unfair procurement practices, and bad faith negotiations. On our side, presidents and politicians have repeatedly failed us by not standing up to China when it violates both written agreements and specific World Trade Organization principles that are required of all countries engaged in global commerce.

To be clear, we do not believe that a trade deficit, on its own, justifies a trade war. Our view is that forceful action is required to stop the unfair trade practices China has deliberately engaged in ever since being admitted to the WTO in 2001.

We are aware that alarms are being sounded about the risks of taking actions that might inhibit global trade. However, we do not subscribe to the conventional view that all trade is good, which we regard as simplistic because it does not take into account the costs and adverse distributional consequences. We prefer the behavioral economic approach, which includes a benefits-costs analysis (BCA). When the costs from lost jobs, stolen intellectual property, fraudulent reproductions, illegal espionage, illegal subsidizations, and many other intentionally aggressive practices are measured, the benefits of trade are significantly diminished.

The existential issue for the U.S. is essentially this: Do we want to continue to be grossly and unfairly mistreated by Chinese trade practices? If the answer is no, then our view is that the U.S. as a country has to come together and define the forceful actions we are willing to take, as well as the economic pain we are willing to endure, in order to drive the Chinese to correct their malfeasance and unfair trade behavior. Diplomacy in the form of summit meetings whose agreements were subsequently ignored by the Chinese has repeatedly failed us, and there appears to be only one approach with a reasonable chance of bringing about respect for, and compliance with, the rules of fair trade. Call it what you like, but it will require fortitude, sacrifice, and endurance on our part for years to come.

The United States has some difficult choices to make if it really wants to have both fair and free trade with China.

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Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk. Past performance is no guarantee of future performance.

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The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 24 Emerging Markets (EM) countries*. With 2,154 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. As of June 2007, the MSCI EAFE Index consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The STOXX Europe 50 index provides a blue-chip representation of supersector leaders in Europe covering almost 50% of the free-float market capitalization of the European stock market. The index covers 50 stocks from 18 European countries: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

The MSCI China Index captures large and mid cap representation across China H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 447 constituents, the index covers about 85% of this China equity universe. Currently, the index also includes Large Cap A shares represented at 2.5% of their free float adjusted market capitalization.

The MSCI Emerging Markets Index captures large and mid cap representation across 24 Emerging Markets (EM) countries*. With 1,138 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The S&P Municipal Bond High-Yield Index consists of bonds in the S&P Municipal Bond Index that are not rated or are rated below investment grade. The S&P Municipal Bond Index measures the performance of bonds issued by state and local municipalities in the U.S. and its territories. All bonds in the index are exempt from U.S. federal income taxes, but some are subject to alternative minimum tax (AMT).

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