The Trump administration imposed tariffs on US$34 billion of Chinese goods last Friday, 6 July. President Trump reiterated plans for a further US$16 billion in trade to be targeted in the coming weeks and plans for tariffs on another US$200 billion of Chinese imports should China retaliate against the new tariffs. Following the move by the US, China has matched with tariffs of its own, targeting US farm and energy exports, including soya beans and crude oil.

We had earlier warned that trade barriers would unsettle markets in the short term and weigh on global growth in the long term (Spectre of trade wars rattles markets). We also highlighted that an escalated trade war could hurt the exporting economies of China, Taiwan, Japan and Korea more than Asean (Trade and Tariffs: Lessons from history).

Early shock transmitters

With Emerging Market economies tightly linked into global supply chains, US-China trade tensions may cause them to be early shock transmitters. See Figure 1.

Some point to China’s May economic indicators as signs that trade tensions are already starting to take its toll. China’s sub-index for export orders slipped from 51.2 to 49.8 in May. South Korea, often seen as a bellwether for the health of global trade, did not provide good news either. South Korea’s June exports fell 0.1% from the previous year against consensus expectations of a 2.2% gain. While the decline can be partly due to fewer working days and a higher base, there is concern that the contraction points to something more ominous.

The disruption to the financial markets has been much quicker. The MSCI Emerging Market Index has fallen 7.7% year to date, with the MSCI Asia Pacific ex Japan Index down 5.4%2. Within Asia, the Chinese, Korean, Thai, Philippines as well as Indonesian markets registered declines of 10% or more.

Figure 1. Emerging Market economies that are tightly linked in the global supply chain may be early shock transmitters1
China trade

Unintended consequences

An interesting study3 on the impact of protectionism and the US stock market suggests that there are few winners in a trade war. The authors examined data between 1960 to 1982, when the US was on a steady course towards protectionism. During this period, the US government imposed nine across-the-board trade restrictions. The study looked at how the US stock market performed across three different time intervals – from 12 months before a protectionist trade policy is announced in the newspapers (event month) to one month before the event month, to the event month itself as well as to six months after the event month.

The results show that the imposition of trade restrictions on average is associated with a decline in the stock market. Although virtually all of the decline occurred before the event month. Further analysis on the effect of trade policies on employment growth in the economy indicated that trade restrictions on average reduce the economy’s efficiency and employment level.

Even more fascinating, perhaps, was the impact on the industries which the restrictions were designed to protect. The study focused on four industries – shoe, colour TV, automobiles and steel - which were affected by industry-specific protectionist policies. The results showed that industry-specific trade restrictions depress the protected industry’s stock index and lifted employment for only the steel industry. See Figure 2.

These historical outcomes may be even more pronounced today given existing global value chains. After decades of globalisation, companies have located activities ranging from design, production, marketing and distribution across multiple suppliers and countries. As such, punishing other countries through trade, for whatever reasons, will likely inflict damage on oneself. It is therefore not surprising that over two thirds of North American and Asia-Pacific Chief Financial Officers (CFOs) in a recent survey5 indicated that US trade policy will have a negative impact on their firms over the next six months.

To further illustrate the point, despite potential tariffs designed to protect the US auto industry, US automakers are down 6.27%6 year to date, with 90% of the decline occurring in June. Likewise, despite the steel tariffs which the US imposed in May, the Dow Jones Iron and Steel Index peaked in February and is flat for the year.

Figure 2. Impact of trade restrictions4
China trade

Key takeaways for investors

With the world likely to be worse off in a full-scale trade war, many hope that the US and China can potentially still reach a deal before the US mid-term elections in November. In the coming months, the outcome for the US ban on ZTE, one of China’s biggest telecommunications firms as well as Qualcomm’s acquisition of NXP Semiconductors will provide hints if relations on both sides are thawing.

Uncertainty over US trade policy is taking place against a backdrop of increasingly desynchronised global growth and central bank balance sheet unwinding. This will likely keep market volatility elevated in the near term. Investors can look to dividends to help buffer their investment portfolios. Low volatility equity strategies can also potentially make portfolios more defensive while still offering exposure to equity markets.

A protected economy or industry, over the long term, will tend to underperform those forced to meet the rigours of international competition. It is notable that the 13% one-day jump in General Motors (GM’s) stock price in May this year was due to news that Softbank invested US$2.5 billion in GM’s self-driving car venture rather than news relating to industry-specific protectionist policy. Focusing on a company’s fundamentals and its competitive strategy remains key for long term investors.

Job losses in the US manufacturing sector and stagnant wages are some of the reasons behind President Trump’s anti-trade rhetoric. Yet, these trends are more due to technology than to trade, and are likely to persist. In “Geopolitical Darwinism in the age of AI”, I wrote that investors need to be prepared for how artificial intelligence will change the geopolitical and investing landscape. Robotics will facilitate further advancements in manufacturing automation. Only economies and companies which take advantage of these developments will continue to thrive amid the ongoing disruption.

 

Virginie Maisonneuve

Chief Investment Officer
Eastspring Investments


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