To understand the U.S.-China trade war, turn not to textbook economics but to kabuki theater.

Tracing its origins to the 17th century, kabuki is the stylized Japanese drama in which performers wear elaborate make-up and costumes. Actions aren’t literal but metaphorical, conveyed through singing, dancing and mime.

To a rational observer thinking along the lines of economic theory, the tit-for-tat tariff battle between the world’s two largest economies makes no sense. Most economists insist that tariffs are not only ineffective, they’re also destructive to all parties concerned.

But mainstream opinion is looking at the tariff battle the wrong way. The key to understanding the elaborate gestures of President Donald Trump and President Xi Jinping lies in their respective political calculations.

Trump clearly thinks that his core supporters (about one-third of registered voters voted for him) don’t want free trade. Even those hurt by tariffs, such as red state farmers, are standing by him…for now. They’re convinced that the Chinese are boogeymen.

Earlier this month, a U.S. State Department official, referring to China, said America for the first time was facing a “great power competitor that is not Caucasian.” Make of that comment what you will. The fact is, Trump is playing to those tribal fears. As impeachment talk grows, he needs his base more than ever.

Xi Jinping is weighing domestic politics as well. The Chinese president can’t afford to “lose face” to America and appear weak, otherwise he would forfeit support among the populace and the top leadership.

Here’s what the shallow news coverage on TV won’t tell you: Even though China is a modern authoritarian regime, it’s still driven by what’s called the Mandate of Heaven, a philosophical concept that goes back to ancient Chinese civilization.

Under this concept, the emperor’s right to rule came from heaven itself. When China flourished, it meant heaven was smiling on its leadership. The converse was true. When China suffered, the emperor was seen to be losing his divine endorsement.

This ancient idea still drives Chinese society. If China loses this trade fight and its economy suffers as a result, it would call into question Xi’s mandate to rule. Sure, Xi has China’s interests at heart. But he also sees tariffs as an existential threat to his own career. If Trump thinks Xi will ever back down, he is sorely mistaken.

Hence, we’re witnessing the theatrics of two leaders pursuing self-destructive policies that benefit neither nation — but which benefit their perceived personal interests. That’s the real meaning behind all the playacting.

Steps to take now…

What’s the upshot for investors? As I’ve repeatedly warned you in previous issues of Mind Over Markets, don’t expect trade war volatility to end until the U.S. presidential election in 2020 is over.

Read This Story: Cry Havoc! And Let Slip the Dogs of (Trade) War

You should adopt a defensive stance, because the on-again, off-again trade war isn’t about policy. It’s about theater.

To prepare for the prolonged volatility ahead, you should pare back your growth stock holdings and elevate cash levels. Pocket at least partial gains from your biggest winners, especially large-cap technology stocks.

Tech stocks stumbled in the latter half of 2018; this year they’re regaining overvalued levels. The U.S tax cut bonanza has helped keep them aloft, but the benefits of tax savings are wearing off, especially as countervailing forces such as the trade war gain steam.

Avoid the stocks of trade-dependent multinationals; transition to value plays and consider small-cap stocks with less overseas exposure. Make sure your portfolio contains hedges and safe haven assets, such as gold.

Dividend-growth stocks are another shrewd defensive strategy now. If a company has the low debt and healthy cash flow required to throw off juicy dividends, it follows that the balance sheet is intrinsically sound enough to sustain the firm through corrections and trade-induced turbulence.

The global slowdown…

Wall Street began last week with a sharp sell-off, as angry trade rhetoric from Trump and Xi fueled concerns that global growth would suffer from threatened tariffs. The Dow Jones Industrial Average dropped 617 points on Monday, or 2.4%.

As the week progressed, however, the markets partially recovered on renewed hopes that trade tensions would subside and a deal eventually would be reached. After considerable volatility, the three major indices ended the week only modestly lower. The Dow fell 0.7%, the S&P 500 fell 0.8%, and the tech-heavy Nasdaq lost 1.2%.

As I’ve noted above, it’s probable that trade headlines will continue to whipsaw investors, as the media overreacts to every pronouncement or tweet. Stick to your investment goals; maintain a long-term perspective and make sure your portfolio is diversified.

We’re now enjoying the longest bull market in history, but along the way, stocks have taken their share of hits, including six 10% corrections. Stocks suffered two 10% pullbacks last year, largely due to trade worries and the Federal Reserve’s interest rate hikes.

Pessimism about the world economy is returning. In April, the International Monetary Fund downgraded its forecast for global growth this year. The following chart paints the picture:

But so far, we’ve only witnessed a deceleration, not a downturn. Economic weakness has been restricted mostly to the manufacturing sector, rather than the still booming service sector. Problem is, manufacturing is especially vulnerable to the trade war. Europe has suffered the most, because manufacturers on the Continent are more exposed than the U.S. to emerging markets.

Germany is the growth engine of Europe and it’s sputtering. A survey of German manufacturers released in April provided unexpectedly bad news. A widely followed business climate index fell to 102.1 points from 103.3 points in March, missing the consensus estimate of 102.6 points. It represented the fifth straight decline in the monthly indicator.

This week in the U.S., the key economic data to watch are weekly jobless claims (Thursday) and durable goods orders (Friday). Investors already are jittery about the health of the U.S. economy; disappointments in these indicators are likely to disproportionately weigh on markets.

Rue Britannia…

Brexit is another concern. Britain’s efforts to leave the European Union are, to use British slang, a “cock-up.”

You think Washington, DC is a mess? To witness even worse political disarray, look to our cousins across the pond. It was once said that the sun never sets on the British empire, but at present the United Kingdom is anything but united.

The Confederation of British Industry reported last week that uncertainty over Brexit is a “crushing disaster” for business in the UK, driving the confidence of corporate leaders to its lowest point since the 2008-2009 financial crisis.

Britain alone accounts for nearly 6% of global stock markets and dominates Europe’s financial services sector. London is home to the world’s largest number of banks and the largest commercial insurance market.

Nearly 40% of Europe’s financial assets are managed in London. Brexit already is undermining the efficiency, transparency and flexibility of doing financial business in London, which is losing banking clients to other European capitals.

Brexit amounts to unnecessary, self-inflicted economic harm. So does the trade war. As these dramas play out, nothing is what it seems. Stay cautious.

Need help interpreting the daily news? Send me your queries: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.