Navigating a Trade War

“The ship was the pride of the American side
coming back from some mill in Wisconsin.
As the big freighters go, it was bigger than most
with a crew and good captain well seasoned.
Concluding some terms with a couple of steel firms
when they left fully loaded for Cleveland.
And later that night when the ship’s bell rang
could it be the north wind they’d been feelin’?”

— “The Wreck of the Edmund Fitzgerald”, Gordon Lightfoot

Navigation through the St. Lawrence Seaway began in 1959. Completion of the joint American and Canadian shipping route was a significant engineering achievement, opening up the agricultural and manufacturing industries in the Great Lakes region to global markets. Although much of the region’s waterway had already been navigable, the St. Marys, Niagara and St. Lawrence rivers had created substantial barriers to international trade. Large ships carrying heavy cargo had simply been unable to pass through the rocks, shallow water, waterfalls, strong rapids, and changes in elevation along these rivers. Overcoming these challenges through a system of channels and locks required significant collaboration and investment from both sides of the border.

In the years that followed, the Great Lakes-St. Lawrence Seaway (GL-SLS) became a crucial foundation of the region’s economy. Large quantities of bulk cargo, such as iron ore, coal, stone, and grain, could now be transported safely and economically for both domestic and overseas consumption1. The route became a key passageway for grain in particular. At peak levels in the early 1980s, almost 18 million tonnes of grain were shipped out of the Port of Thunder Bay to destinations in Europe, the former Soviet Union, the Middle East, and North Africa.2 Later, as railways expanded their westward capacity and Asian demand for grain grew, shipments transported through the St. Lawrence dwindled. The world’s largest inland marine shipping industry, with its high fixed costs and declining volumes, was in trouble. That is until about five years ago, when the industry began staging a significant comeback.

As crude oil began to take an ever larger share of railway capacity, Manitoba farmers rediscovered the appeal of marine shipping via the Port of Thunder Bay. Around the same time, steel imports to Canada were on the rise, bringing more freighters to the Canadian side of the Great Lakes region. These additional ships translated into greater outward shipping capacity since the ships bringing in goods through the GL-SLS from international markets (known in the industry as “Salties”3) must come back out. The cost of sending out an empty ship (“carrying air”) is high. According to one international shipping firm, the variable cost of a single, one-way journey through the seaway – which takes six days on average – could easily reach C$140,000 or even double that in the winter months.

Pairing the import of steel with the export of grains is therefore very beneficial for both industries as they can share the cost of moving a vessel through the system. As such, a ship that has delivered steel to Canada or the U.S. is often loaded with grain for the return journey. The same international shipping company referenced above estimated that 95% of their import volumes along the GL-SLS in 2017 were steel products, and 85% of their exports were grains. The downside to this beneficial arrangement is that altering volumes of one commodity, through the introduction of a tariff on steel or automobiles, for example, may have important and unintended consequences for the other commodity.

A New Trade Era

As in the Great Lakes region, trade has expanded globally since the end of the Second World War due to technological innovation, policy, and international collaboration. Between 1960 and 2008, global exports as a percentage of GDP increased from 12% to 31%.4  Most economists would agree that the expansion of global trade has been a net benefit to most countries around the world. For example, even though volumes are down from their peak, the Bank of Montreal estimates that today the Great Lakes-St. Lawrence region accounts for nearly a third of combined Canadian and U.S. GDP, jobs, and exports.5

There is little doubt that President Trump, driven by his low opinion of virtually all the United States’ major trading agreements, is ushering in a new era in global trade. In recent months, Trump has introduced tariffs on a number of imported goods in an attempt to support domestic industries and lower the U.S. trade deficit with certain countries, particularly China. The restrictions started off small, with tariffs on washing machines and solar panels earlier this year. Steel and aluminum tariffs followed a few months later. Then in the beginning of July, the U.S. began imposing 25% tariffs on a basket of Chinese goods worth US$34B.

Retaliation by other countries is the riskiest part of Trump’s trade agenda. So far, the European Union and a number of countries, including China, Canada, and Mexico have responded with countervailing tariffs on U.S. goods ranging from bourbon to Harley Davidsons to soybeans. These retaliatory measures have been strategic, often targeting industries that are particularly important to Trump’s supporter base, enraging the U.S. President and prompting further action. The United States is now considering tariffs on US$200B of Chinese goods.

We have seen global trade tensions escalate before. Perhaps the most famous — and severe — example was the passing of the Smoot-Hawley Act of the 1930s. What began as a plan to help American workers find jobs in distressed industries ultimately resulted in tariffs of 40% on average being applied to over 20,000 items. The United States’ trading partners retaliated, leading to higher costs for goods, job losses, and a decline in global trade.

It is important to keep in mind that unlike in the 1930s, American import tariffs are currently sitting at historic lows. Even so, the magnitude and complexity of global trade today means substantial consequences may arise from the new trade restrictions. Bluntly applying tariffs on materials such as steel and aluminum has the potential to raise the costs of downstream producers of domestic goods, such as the automotive and construction industries. Considering these costs in conjunction with the impact of retaliatory tariffs from other countries, the steel and aluminum tariffs alone could cost 400,000 net U.S. jobs.6

Portfolio Management in a Trade War

Economists globally believe that tariffs will be damaging to the economy, creating a consensus among individuals that rarely agree. If history is any guide, increases in the price of key manufacturing inputs (such as steel and aluminum) will either be passed along to consumers or, in the case of products with little pricing power, will cause reduced corporate margins. In either scenario, it is likely to lead to lower earnings growth and, in turn, valuations.

If stock markets generally don’t react well to tariffs (which lift costs, have the potential to cause shortages, and hurt corporate profits), then why haven’t we seen more stock market volatility in recent months? It could be due to the relatively small size of the tariffs announced so far. Although US$34B of tariffs on Chinese imports may seem like a significant sum, it amounts to a tax increase for the U.S. of approximately US$8.5B per year. To put this in context, Congress passed US$150B in corporate tax cuts in 2017, which has significantly improved free cash flow for U.S. companies this year. Additionally, with many of the tariffs going into effect in early July, investors have yet to see what impact they may have on company results.

Investing is a forward-looking endeavour; however, it is challenging to predict who will ultimately be affected in our globally interconnected supply chains. News of the steel and aluminum tariffs may have rattled some investors in the industries that are directly affected, but how many are thinking about the ripple effects to grain producers in the Canadian prairies? What do steel tariffs have to do with the price of grain?

With trade risks elevated, what are the implications for our investments? The short answer is that we cannot know with certainty. We are comfortable that we have no direct exposure to the sectors and products targeted by the tariffs to date. Still, we cannot predict how far tensions will escalate, and we do not know all the industries that will be indirectly affected. In recent weeks, we have spoken to the management teams of many of the companies we own. These highly capable executives with intimate industry knowledge do not have all the answers either.

As many of our readers will know, a core investment principle at Burgundy is that the future is inherently unpredictable. As such, we avoid making bets on macroeconomic developments; we do not speculate on interest rates; and we often avoid commodities, where the products are undifferentiated and companies are unable to set the price of their products. We do not try to time the markets. Instead we look to own quality companies that can survive any of the surprises the global economy throws their way. These companies tend to have competitive advantages, adaptable business models, and financial and operating flexibility.

If you own high-quality companies and buy them at reasonable prices, as we strive to do, you don’t have to spend a lot of time and energy worrying about these highly unpredictable events. We take these developments into consideration, but we are more naturally shielded from them as a result of our investment process.

1. The sinking of the Edmund Fitzgerald was a notable exception. Otherwise, safety along the seaway is considered much higher than that of the rails according to analysis by the Great Lakes Seaway Partnership.


3. A Saltie is a type of ship that is able to enter both the oceans and great lakes. Ships that are confined to sailing in the Great Lakes are called Lakers.




This post is presented for illustrative and discussion purposes only. It is not intended to provide investment advice and does not consider unique objectives, constraints or financial needs. Under no circumstances does this post suggest that you should time the market in any way or make investment decisions based on the content. Select securities may be used as examples to illustrate Burgundy’s investment philosophy. Burgundy funds or portfolios may or may not hold such securities for the whole demonstrated period. Investors are advised that their investments are not guaranteed, their values change frequently and past performance may not be repeated. This post is not intended as an offer to invest in any investment strategy presented by Burgundy. The information contained in this post is the opinion of Burgundy Asset Management and/or its employees as of the date of the post and is subject to change without notice. Please refer to the Legal section of this website for additional information.