How To Trade a Trade War -- Streetwise
June 21 2018 - 12:09PM
Dow Jones News
By James Mackintosh
Markets follow a well-worn pattern after Donald Trump's
pronouncements, a pattern followed by tax, North Korea and trade.
There is a sharp reaction -- up or down -- on the first news,
fading as doubts that the president is willing to follow through
set in. Then there is another panic on the realization that he is
serious, and finally the market prices in the details of whatever
compromise he settles on.
The Trump trade war briefly reached the realization phase on
Tuesday, but markets are still waking up to the idea that trade
battles are more than a sideshow. Investors who think China won't
back down still have plenty of opportunity to get out. They also
have a problem: get out of what, exactly?
It is exceptionally hard to work out how to price in a prolonged
trade fight. So far investors have turned to simple rules of thumb,
but ignoring the complexities won't make them go away. The basic
rule is to avoid companies with big Chinese exposure, particularly
those that could also make handy high-profile targets for foreign
retaliation.
So far that has meant selling shares in Caterpillar and Boeing,
preferring smaller stocks to bigger ones, and preferring the U.S.
to emerging markets, especially China and big trading partners such
as South Korea.
"There were a lot of assumptions that these tariffs were simply
negotiating tactics and we would come up with some sort of
agreement and they wouldn't be put in place," said Robert Baur,
chief global economist at Principal Global Investors in Des Moines,
Iowa. "That's clearly not right, but how far it is going to go we
don't know."
The first corporate information knocked shares in German car
maker Daimler down 4% on Thursday. It said profits would be hurt as
China's retaliatory tariffs on U.S. light trucks hit Mercedes SUV
exports from its Alabama factory. But information about other
companies is sparse, partly because supply chains are so
complex.
Tuesday's price drops showed that China-related stocks in the
U.S. are sensitive to trade fears. All but one of the 14 S&P
500 members that make more than a quarter of their revenue from
China fell by more than the index.
Yet, the same stocks suggest that trade war fears haven't sunk
in properly, with six of them up and seven down since the day
before the announcement of tariffs on the first $50 billion of
Chinese goods in March. Caterpillar and Boeing tell the same story,
with their shares falling hard this month but being dominated by
other issues until then.
This makes sense. It is hard to price in something you don't
understand, and the implications of a trade battle are obscure, at
best. Not only do we not know precisely which products will be
targeted in the next round, or how long the tariffs will last, but
we have little understanding of complex corporate supply
chains.
Measures of revenue exposure to China -- or of Chinese corporate
exposure to the U.S. -- don't capture the complexity of modern
manufacturing, either. U.S. company Qualcomm has microchips made
for it in Taiwan, before they are sold into China to make mobile
phones and shipped abroad. Even if China extended tariffs to U.S.
chips, those made in Taiwan wouldn't be covered.
On the other hand, if the U.S. extends tariffs to consumer
goods, then the suppliers to imported phones, including Apple's
iPhone, could be hit. Ironically, a successful U.S. company is more
exposed to possible U.S. tariffs on China than it is to Chinese
tariffs on the U.S. Even worse is for chip makers who do produce in
the U.S. and sell to China, as they might be hit twice, once if
China levies a tariff on their chips, and once if the U.S. charges
a tariff on the phone imported back from China.
UBS strategists who tried to isolate Asian stocks embedded in
global supply chains also found little effect, until very
recently.
The biggest effect has instead been on wider markets and
currencies. There has been no link between how much of an Asian
company's sales come from the U.S. and its stock performance in
local currency terms, according to data from S&P Capital IQ.
But include the effect of currency moves, and U.S.-exposed Asian
stocks have underperformed by about 10 percentage points, UBS
found.
The simple rules of thumb -- sell China, sell Korea, sell
emerging markets, prefer smaller to larger U.S. stocks and buy the
safe-haven dollar and bonds -- have been working better than
detailed analysis so far, in part because the prospects for a trade
war are still so uncertain. If it becomes clear that new trade
barriers are here to stay, understanding both the details of which
companies will be hit and the knock-on effects on the economy will
matter more.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
June 21, 2018 11:54 ET (15:54 GMT)
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