Contrary to the beliefs of the US president, there can be no “winner” from any trade war. It may be seen as the start of a negotiating tactic to reach some compromise but markets will sell off as uncertainties arise.
The hope is that cooler heads ultimately prevail and China adopts more of a measured stance on the matter.
In our view, this presents another of those buying opportunities where the economic reality for China and the local universe of stocks is not as material as many perceive. China’s economy has rebalanced over the years to the point where domestic demand now represents some 55% of GDP.
Although US-Sino tensions appeared to recede somewhat as Easter approached, it would seem unwise to rule out further posturing and counter-posturing over the weeks and months ahead. However, the one resounding observation is that it is difficult to see how the US could benefit from the imposition of tariffs and counter measures since the Trump administration is not holding any of the aces. Having failed to invest in sensible or sustainable infrastructure over the last 40 years, US steel production facilities are inefficient, obsolescent and incapable of competing with high-grade overseas steel producers, regardless of a 25% import tariff. Furthermore, under such conditions, the major US players in non-aluminium aerospace production, auto manufacture and heavy industry will simply have to pay significantly higher input costs for the sake of non-material US job creation. This in turn would present opportunities for European steel producers, with, for example, the dominant Dutch player’s business mix being primarily focused on high-performance steel which the US cannot manufacture. It is also worth bearing in mind that any retaliatory measures on the part of China are likely to involve the levy of much greater premiums on Chinese-produced electronic components on which the US is highly dependent. A trade war is a battle that could create opportunities – but not in the manner the Trump administration intends.
We have already engaged with a number of companies in which we are invested on this topic, but we have been unable to gain any sort of consensus because so much is dependent on the intricacies of individual supply chains. Clearly, some corporate executives have a deeper understanding of their supply chain than others and this is likely to prove a significant competitive advantage in terms of responding to the tariffs as and when they are introduced. However, in overall terms, we believe it is impossible for the market dimension of aggregated idiosyncratic dynamics to be gauged accurately in advance. Moreover, while it would be easy to say that the implications of a trade war are bound to be negative, it is always important to appreciate that the adversity of one corporation typically creates opportunity for another. Consequently, we need more time to see the dynamics unfold but firmly believe a trade war will ultimately highlight the value of a nimble and active approach to investment in Japanese equities.
Given that the potential for a trade war has grown out of the Trump administration’s protectionist agenda and its desire to reduce the nation’s trade deficit, export-oriented economies, such as Germany, would inevitably suffer some negative implications. Premium carmakers would likely be among those businesses that suffer the most, but the fact that they also have a production base in the US should offset the potential impact to a certain extent. Other German industries with significant US exposure include consumer discretionary, machinery, chemicals and pharmaceuticals. However, this is not just a one-way street and, for all the grandiose rhetoric, our central case is that an escalation in trade tariffs and counter measures is ultimately something that all parties should, and will, be wary of. Clearly, the engineering of USD weakness would offer another potential avenue for President Trump in his attempts to diminish the US trade deficit. And, while German equities tend to be negatively correlated to a strengthening euro, FX manipulation is likely to prove less corrosive than a tariff shock.
President Trump’s authorisation of 25% tariffs on USD 50 billion-60 billion of imports from China was met with a counter measure of tariffs on USD 3 billion of US products. While uncertainty related to a trade war dampened investor sentiment, most listed Chinese and Asian companies have very low revenue exposure to US exports. The tariffs and risk of trade wars could, however, impact specific Chinese and Asian industries such as communication equipment and electronics. In our investment strategy, we favour Chinese and Asian companies driven by domestic demand or Asian regional demand, such as healthcare, financial services, technology and the broad consumer sectors. These sectors and industries would not be directly impacted by tariffs and trade wars. On the other side, US companies with large revenue exposure to China could face risks if China targets US business interests in China as retaliation.
President Trump’s protectionist policies will inevitably be negative for globalisation but, in overall terms, the implications for American commodity markets should unquestionably prove positive. The mercantilist ideology of 'America First’ will drive US domestic prices up but, at the same time, the valuation of the US dollar on FX markets will be driven lower. Since commodities are the best hedge against inflation they will benefit greatly from this dynamic. Thus, in this new state of war, commodity shortages will not appear “naturally” anymore - a rundown in inventories of raw materials will effectively be engineered via a combination of tariff walls and currency debasement, ultimately leading to a major shift in the supply / demand dynamic.