Investors are watching as the world?s two largest economies tiptoe around a trade war. On July 6th, President Trump carried out his threat and slapped $34 billion worth of tariffs on Chinese goods. Immediately China reciprocated and imposed tariffs on U.S. goods from soybeans to Teslas. Four days later President Trump escalated the feud and threated to impose an additional tariffs on an additional $200 billion in Chinese products. President Donald Trump?s declaration that ?trade wars are easy to win? will now be put to the test. We don?t need to hit the panic button just yet but we are moving closer to it. This could be the art of the deal in negotiating or fulfilling promises made to his electoral base during his Presidential campaign. Whichever it is, it looks fairly messy because it is causing confusion and it is causing risk.
If the trade situation escalates and both countries apply across-the-board 30% tariffs on each other?s exports, we believe it will reduce global economic growth by 1%. Furthermore, if the additional $200 billion of tariffs come into effect, the impact will be felt larger on the U.S economy than on the Chinese economy as the U.S. is signalling to the world about isolationism through the imposition of automotive, aluminium and steel tariffs whereas China is not cutting itself from the global trading system. China is by far the largest provider of consumer products to the U.S. If the U.S. implements the next $200 billion in tariffs through what we believe will be a 10% tax on U.S. consumers, this will have a greater impact on the U.S. as it will be imposed on a broad range of goods and consumers will notice when prices increase.
Affecting Fed Policy.
The further we go down the path of U.S. isolationism the more questions are raised. The Federal Reserve was already stating that global companies are rethinking investment in the U.S. because they are probably wanting to start shifting production out of the U.S, as we saw with Harley Davidson, because it is a much more sensible, lower risk strategy. It is not U.S. companies that are being attacked. It is companies with production physically in the U.S. that are being attacked. Therefore, moving production across the border into either Canada or Mexico or even moving production to Europe is a solution and this is of great concern for the Fed.
We are of the view that the ECB will cease its QE program as it has announced and tighten monetary policy through an increase in interest rates during the second half of 2019 which should support the euro when trade tensions ease.
Ironically the U.S. dollar is being supported by trade war threats because it wouldn?t be specifically a U.S. event as it will affect global growth and in those circumstances investors would move from risk assets into safe haven assets with the biggest safe haven market being U.S. Treasuries. If a trade war does not eventuate, then we will see a reversal of this current pattern with the euro increasing particularly if the ECB tightens policy next year.
It can be argued that Germany is in a good position. While the U.S. is an important trading partner, Europe is much more important to Germany along with Asia and there are no problems in trading with Europe (with the exception of UK as they still need to sort out a few things!), Japan or Canada giving it an advantage over the U.S.
However, a damaging trade war will hurt Europe the most as despite being somewhat of a bystander in this dispute, European shares have greater international exposure and react greater to market movements. The European Union is the largest exporter of motor vehicles in the world, whereas the U.S. is the largest importer of motor vehicles in the world. New tariffs on EU cars would have a significant impact with Germany alone representing 55% of total EU car exports in 2017. Lower profits are negative for car firms and equity investors, given that it is less likely they will receive dividends.
The car industry will be facing some major challenges going forward as there is currently no policy that the EU could implement to offset such an impact. We don?t expect an increase in Germany car exports with the economic impact on German GDP to be around 0.2% and for the EU less than 0.1% for 2019. A lower euro could offset the impact of U.S. car tariffs as a lower currency equates to lower prices. However, as we have mentioned many times previously, we expect the euro to gradually increase to 1.30 against the U.S. dollar over the next 12 months.
Going forward we still remain wary as we await possible trade reprisals from China which could fuel inflation from rising prices and may lead to job cuts and slowing production in the U.S. dragging down U.S. GDP growth.? However, we believe somehow the adults in the Trump Administration should win the argument against the next round of trade tariffs and a solution of some sort will be agreed too with Beijing and should prevent a big escalation of tariffs and non-tariff barriers erected between U.S., China and other countries. With this in mind, we would advise investors to buy shares in sectors that have been unfairly penalised by the trade discussions. For example, we would look at buying shares in Chinese companies that are focused more on the healthcare and consumers exposed to China?s growing middle-class and resilient to external turbulence and has trading links with Hong Kong. We would continue to buy Kweichow Moutai Co., the world?s biggest distiller; Han?s Laser Technology Group, maker of laser-based products; and Jiangsu Hengrui Medicine Co. as a reflection on Chinese wanting better medical coverage.