Investors have options to tackle U.S. trade war
Damage small so far, but tariff tiff has potential to get big, Jonathan Ratner says.
Equity markets are taking it one day at a time as Canada, Mexico, the EU and, most recently, Russia join China in retaliation against U.S. tariffs. So far the damage stemming from the titfor-tat dispute has been limited, but the threat of an all-out trade war looms.
U.S. President Donald Trump has threatened to tax as much as US$550 billion worth of Chinese goods, which is more than the United States imported from China in 2017.
How should investors approach something that has the potential to disrupt the global economy and shake up financial markets around the world? Here are some ideas for trading the trade war.
BUY CHINA
This would have been a contrarian trade even before the trade dispute heated up, as Chinese stocks have been trending downward all year, with the Shanghai Stock Exchange Composite Index off more than 20 per cent since late January.
But investors like John Pearce, chief investment officer at Melbourne-based UniSuper Management, are taking advantage of the buying opportunity.
“We have used the latest selloff to build a position in China A shares,” Pearce said. “It’s all on the back of tightening U.S. dollar liquidity and fears of a trade war but it looks overdone to us.”
An investment in Chinese stocks assumes the global business cycle remains healthy, and that ongoing trade uncertainty drives further monetary policy easing and other measures in the world’s largest exporter of goods.
That could further reinforce growth firming in the second half of the year, said John Normand, head of cross-asset strategy at J.P. Morgan, which would be another positive development for Chinese equities.
CONSIDER EMERGING MARKETS
Major equity indexes in nations like South Korea and Indonesia have also been falling in recent weeks, but emerging markets as a whole represent a lower-risk way for investors to capitalize on negative sentiment than putting their money into China.
“We believe emerging market concerns are increasingly pricedin at this point,” said Martin Roberge, portfolio strategist at Canaccord Genuity.
Emerging markets also stand to benefit if companies opt to move manufacturing outside China.
Hemp Fortex Industries Ltd., a Qingdao, China-based supplier of clothing and natural fabrics to U.S. and European brands, has already got the ball rolling. Since more than half of the company’s revenue comes from American customers, it could be heavily exposed to U.S. tariffs.
“Our big clients now are very actively discussing with us on how to shift more production from China to Southeast Asia,” said founder Ding Hongliang. “The U.S. is a great market that cannot be replaced by anywhere else.”
If a truce is called soon, then EM assets are looking pretty cheap, as they are pricing a fairly large one-per-cent slowdown in global growth, according to J.P. Morgan. However, that is an unlikely outcome if only US$35 billion to US$50 billion in tariffs are imposed.
SEEK A SAFE HAVEN ASSET
Gold and the U.S. dollar are both frequently considered safe haven assets, making them an attractive place to park during uncertain times, and more so if a trade war wreaks havoc on financial markets.
However, the price of gold is usually inversely linked to strength in the greenback, which means they don’t always respond in the same fashion.
So far, gold has yet to catch the eye of investors, continuing a decline that began in March 2018, when the dollar started to gain momentum.
“The only thing that is driving gold at the moment is the dollar,” said Georgette Boele, commodity strategist at ABN AMRO in Amsterdam.
Most analysts predict that the greenback will out-perform against other currencies in a trade war, something that could spell further trouble for gold.
There are, however, periods when the yellow metal has had a positive relationship with the U.S. dollar, and the current level of political uncertainty and lofty valuations for U.S. equities certainly bode well for gold.
“While our work suggests falling gold supply leads to higher real metal prices, that opportunity will likely only come once dollar strength eases, and it’s difficult to predict when that will happen,” said John Bridges, an analyst at J.P. Morgan. Both the currency and treasury market have been sensitive of late, as the U.S. dollar index is up more than four per cent since March 1.
BET ON METAL
Equity investors may be keeping it cool, but metals traders are making their opinions heard.
Tariffs have provided a big lift to steel and aluminum prices in the United States, and while manufacturers stand to take a bit hit as a result domestic producers like Nucor Corp. and U.S. Steel Corp. will get a boost to their bottom lines.
Both zinc and copper have suffered on concerns that demand will slow. Copper, a popular bellwether for the global economy, has shed 14 per cent since early June. Prices are down more than US$1,000 a metric ton since hitting a four-year high on June 7, marking the sharpest four-week pullback since 2011, but not everybody believes the long-term bull market is over.
Trade conflicts and threats of tariffs on U.S. auto imports have also impacted metals used in rechargeable batteries, and may constrain the industry as automakers hold back on commitments to new product lines.
AVOID SMALL CAPS
Despite their general association with the U.S. economy, small caps actually appear much more vulnerable than large caps amid a trade war. That’s because they have lower margins and a lower reliance on foreign subsidies.
“The outperformance of small cap versus large cap stocks since March is unjustified,” said Mannish Deshpande, a New Yorkbased strategist at Barclays.
While small caps only get 20 per cent of their sales from foreign markets, versus 30 per cent for large caps, the level of exports determines the impact of tariffs.
Deshpande believes these are likely higher for small caps because unlike large multinationals, they probably don’t have foreign subsidiaries that make related sales immune to tariffs.
Since margins are substantially lower for small caps, additional tariff-related costs have a much stronger impact than they do for larger companies. Small caps also likely have less pricing power, which makes it more difficult to pass higher tariff costs onto customers.
“Thus, paradoxically, small caps are more exposed to a trade war and hence at current levels their risks are asymmetric to the downside,” Deshpande said. Financial Post
With files from wire services