Mark Williams

Trade Wars – may the force be with you

Mark Williams

Chinese tanker

Analysis of the market’s reaction to Trade Wars news flow has led to investment opportunities for the Liontrust Asia Income Fund; Mark Williams explains how.

Good news for any Americans planning to gift their loved ones some live mushroom spawn, handkerchiefs (not knitted or crocheted, of man‐made fibres), or wigs, false beards, eyebrows and the like (of human hair).

President Trump has decided to postpone levying higher tariffs on these goods from 1 September to 15 December. Trump has described the delay as a pre-Christmas boost to US consumers and the list does also include some more likely seasonal purchases; “cell phones, laptop computers, video game consoles, certain toys, computer monitors, and certain items of footwear and clothing” have all found their way on to US Trade Representative List 4B.

The fact that Trump views the delay as a positive for consumers suggests that he does in fact understand economic theory so far as the flexibility (or elasticity) of demand for a product determines whether the burden of import tariffs falls on the good’s provider – in the form of lower demand – or on the consumer via higher prices.

This same principle has allowed us to assess instances where Trade Wars news flow has led to Asian stocks being oversold.

This month’s tariff delay is only the latest instalment in a narrative which has dominated news flow for investors in Asia over the last year. Asian markets have suffered three large tariff-triggered bouts of weakness over this period (at the time of writing). Despite these sell-offs, the MSCI Asia Pacific ex-Japan Index has offered a pretty much flat return in sterling terms.

MSCI Asia Pacific ex-Japan Index sell-offs 

The Liontrust Asia Income Fund, which for a number of years has had a sizeable allocation towards Chinese and Hong Kong equities, has been affected by the volatility in Trade Wars news flow. However, the impact may not have taken the form that you would expect.

Because tariffs have been threatened for much longer periods than they’ve actually been wielded, they’ve had a much bigger impact on investor behaviour than on company sales and earnings.

As a result of the Trade Wars rhetoric, the Fund has been up against a headwind of risk-averse behaviour – a headwind that it has been able to push through due to decent returns from stock selection, meaning that the Fund is a little ahead of the regional index over the year.

Investors have looked to shift into areas that provide havens from negative trade developments. This means they are likely to prefer developed regional markets like Australia and defensive sectors such as real estate investment trusts (REITs), which have also benefited from their bond-proxy status as flight-to-safety behaviour has pushed bond yields to all-time lows. Large-caps have also tended to be favoured over small and mid caps during bouts of nervousness.

All of these trends are to the detriment of the Fund, which relative to regional indices is overweight mid and small caps, underweight Australia and has only a few REITs.

While it might seem tempting to increase our Australian exposure to negate these relative headwinds, we don’t think this is the best way to achieve the Fund’s investment mandate. We are looking for companies whose earnings and dividend growth profile is reflective of the region’s economic development, not mature developed market stocks that could as easily be listed in London as Sydney.

While investor behaviour has been a headwind, the underlying corporate environment has been relatively benign. The Q2 earnings season provided the usual mixed-bag for our portfolio of stocks – a variance in fortunes which we expect over such a short time period. But there was nothing to suggest that investors should be running for the hills due to Trade Wars, even if the prospect of “macroeconomic uncertainties” now seems to be a standard-issue insert for companies’ outlook statements.

Where other investors have perceived that stock valuations are fundamentally undermined, we have in a number of instances been able to take a view against the market to the benefit of the Fund.

The Taiwanese stocks held in the Fund are a great example of this. Alongside our holdings in Thailand, these have contributed the majority of the Fund’s positive stock selection effect over the last year.

As technology stocks with Chinese manufacturing sites, the Taiwanese companies have been viewed as clear losers from tariff imposition, triggering double-digit share price falls in last year’s first tariff sell-off. Late last year, we drilled down into these stocks’ product ranges, modelling the bear case impact of tariffs – where the companies assumed the full economic impact. We also modelled a base case scenario which reflected our understanding of each company’s pricing power – meaning they could pass on some or all of the tariff to the consumer – as well as the ability to shift manufacturing to Taiwan or elsewhere in order to dodge the US-China tariffs.

For all of the stocks we owned in Taiwan, our analysis suggested that share price falls significantly overestimated the trade risks. We therefore added to all of these positions. Over the last year, this one exercise contributed a substantial proportion of the Fund’s positive attribution. King Yuan Electronics, Lite-On Technology, Lotes and Wistron are among the stocks to deliver double-digit percentage contributions.

Opportunities continue to emerge as a result of the latest tariff-driven sell-off. In July we were able to buy up shares in a new stock – Merry Electronics – at levels almost 20% below their 2019 highs. The Taiwanese headphones and speakers specialist has experienced rapid growth in sales of true wireless stereo headsets. We do not think tariffs will significantly impinge on Merry Electronics’ ability to exploit this booming demand. While it does have manufacturing operations in China, it also operates out of Thailand and Singapore. More importantly, demand for stereo sound in Bluetooth earphone buds is likely to prove relatively price elastic, so consumers will probably be willing to foot the bill for any tariffs incurred.

Donald Trump’s Christmas gift to his voters is actually just a temporary measure that confirms what we all know: tariffs are a tax on US consumers as much as Chinese manufacturers.

For a comprehensive list of common financial words and terms, see our glossary here.


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. 


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. Article content goes here

Tuesday, August 20, 2019, 10:13 AM