Mark Williams

Trade war perceptions shift ahead of US mid-terms

Mark Williams

Mark Williams Trade War


Investor sentiment has been particularly fragile in recent weeks, not helped by ongoing concerns regarding US-China trade tensions. We’ve taken an in-depth look at the short and long-term impact of trade tariffs under a range of scenarios. We found that whether Trump’s ultimate aim is short-term appeasement of US voters or longer-term containment on China, the risks are – in our view – already priced into markets. More specifically, we applied bear case trade tariff assumptions across our portfolio and concluded that the impact on exporters will not be as big as some fear. Because an overly pessimistic view has been factored into share prices, we see little reason to alter portfolio exposure now.


As we head towards mid-term elections next week, investor perceptions about the US relationship with China have changed. While the majority of the world (ourselves included) originally thought that Trump’s trade posturing was just that, posturing, there is a growing belief that he is actually trying to contain China’s rise in global stature.


Our original view – that China would likely be used as a villain to play to Trump’s voter-base – has not been entirely derailed by events, but, as the current trade wars slowly ratchet up with few conciliatory gestures from either side, the likelihood of a quick win obviously recedes. Increased US military pressures also makes a rapprochement harder.


To recap on how things stand, at the 2018 halfway point the US had announced tariffs covering 2.3% of China’s total exports and China had responded with measures affecting 3.5% of US exports. China had also made some pacifying concessions such as greater foreign ownership and promises of more intellectual property rights protection. To be fair to Trump, these are areas that definitely need addressing for a fairer trade environment. Had Trump gone on to declare victory in this particular battle, this would have represented a reasonably benign outcome for investors: symbolic tariffs with fairly moderate economic impact, and some necessary concessions from China. But instead things have escalated further. Trump imposed tariffs on US$200bn of Chinese imports, effective from 24 September at 10%, due to rise to 25% in January 2019. China responded with tariffs on a further US$60bn of US goods, at levels varying from 5% to 10%. Trump also came out with yet another list of US$267bn further goods he might target. China exports around US$500bn of goods to the US, so this would effectively cover the lot.


Our base case remains that Trump is still looking to engineer a ‘victory’, publicity from which will far outweigh long-term economic impact. Global muscle-flexing appears to have increased Trump’s popularity at home so the current escalation of tensions could be part of a strategy to concoct some timely headlines. While this strategy might lead to rising prices that could test the enthusiasm of both corporations and voters, the short-term political benefit seems clear. Having said that, things have already gone further than we originally expected, with likely longer-term effects.


The direct impact on exporters will not be as big as some fear. We looked at our portfolio exposure to exports from China to the US, modelling the share price impact of a pretty bearish scenario: 25% tariffs on all such exports, with the exporters absorbing all the costs. We found that the recent sell off had more than factored this into share-prices. This scenario itself is overly pessimistic, as most companies would be able to avoid or pass on at least some of the costs. Part of the production could be completed in other countries – our investments already tend to have manufacturing bases outside of China, and only a proportion of work has to be completed in a third country to claim a product is local not Chinese. A further part of the cost might be passed on to purchasers, as initially there will not be sufficient capacity elsewhere, particularly in complex supply chains such as technology, meaning that US importers are tied to their suppliers. This is not to mention the relief already provided to exporters by a weakening yuan.


The more significant longer-term impact is likely to come from an ongoing need for companies to ensure they have sufficient capacity outside of China. This will apply to both developed world and Asian manufacturers, and is already happening locally. We have spoken to one company that is looking to re-open Philippine facilities which were last operational 14 years ago, and from others it seems that Vietnam is likely to be one of the biggest beneficiaries of the process. Few executives have any strong opinion whether trade wars will escalate further or subside, but they all understand they need to prepare themselves for a global trade order that may be different from recent history.


The lack of investment will damage China’s growth prospects to some degree, but the government has already implemented measures to stimulate the economy. Taxes have been cut, export tax rebates have increased, local government spending initiatives ramped up and banks given more flexibility to lend while some of the country’s more progressive, and needed, reforms are not being pursued so aggressively. For example the government clampdown on inefficient capacity for environmental reasons might be eased up in the near term to support growth.


So where does this leave us? Trade wars are destructive, and this one is worse than we would have predicted a year ago. It will lead to higher prices for US consumers, with a likely fall in demand, greater investment costs for Chinese manufacturers, and extra capacity in other countries that would not otherwise have been necessary. Markets are very swift to discount events, however, and seem to have already priced in the effects of trade measures so far. Because they also seem to be partly driven by investor sentiment rather than changes to longer-term fundamentals, markets look oversold in our view.


The fragility of sentiment is not unusual, and other events (global interest rates rising, Brexit, Italy, the end of quantitative easing) make this understandable. We do not believe that it is right to sell into this market, however. Asian markets have fallen over 20% already from this year’s January peak, and valuations are now approximately one standard deviation below their historical mean. We obviously cannot predict whether Trump really does believe in containing China or appeasing his voters, but either way it seems that many of the risks are already priced in.

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 


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Friday, November 2, 2018, 12:01 PM