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#Investments — 28.03.2018

Equities: the return of protectionism?

Guillaume Duchesne

Protectionism is a risk for equity markets. What is the impact on different industries?

The global economic environment remains buoyant, but protectionism issues have become a top concern for investors once again.  Donald Trump's comments and announcements have fuelled fears of more difficult relations with the United States' main trading partners, in several respects:

  1. the introduction of an import duty on steel and aluminium entering the United States;
  2. measures against China, which is violating intellectual property rights according to the United States;  President Trump's goal to reduce the United States' vast trade deficit with China;
  3. criticism of excessive import duties practised by European authorities, particularly against American car manufacturers;   
  4. questioning of strategic mergers for internal security reasons (for example, between Broadcom and Qualcomm in semiconductors) and
  5. renegotiation in progress of North American Free Trade Agreement (NAFTA) agreements with Mexico and Canada.

 

Until recently, investors did not seem to believe in the worst-case scenario. Carried by the hope of possible negotiations between countries, they ruled out the possibility of a trade war involving massive retaliatory measures. Such an outcome would be dramatic for the global economy and would call into question the currently synchronised growth and solid prospects for company profits. However, tension on the stock markets has risen in recent days. On Thursday 22 March, equities reacted violently to Donald Trump's press conference during which he confirmed his intentions with regards to China. The result was a decline of nearly 2% in developed and emerging countries. It is extremely difficult at this stage to say how far tensions between different countries will go, but an escalation would be unfavourable to all parties. We therefore believe that trade tensions will persist, but will not degenerate into trade wars. However, it is interesting to estimate the consequences of such measures on various industries:

 

  • European automotive under pressure: The European sector exports €38 billion (including €22 billion from Germany) to the United States. Some manufacturers assemble some of their production in the United States, but an increase in the import duty to 35% (mentioned in January by Donald Trump versus 10.5% currently) would have a very negative effect on their revenues.  We are also cautious about the industry. For more details, see our article Equities: is the automobile sector in turmoil?

  • Import duties on steel and aluminium, a limited effect finally. Import duties on steel and aluminium (25% and 10% respectively) have been announced in order to reduce the production overcapacities in these two industries. They come on top of symbolic measures taken at the end of 2017 on solar panels (a 30% import duty) and washing machines (20%). However, the effects on steel and aluminium worldwide could be limited. On the one hand, the United States represents only 5% of world steel demand. On the other hand, the most affected trading partners are not China, but rather Canada ($6 billion in imports), Brazil ($4 billion), then South Korea and Mexico, which happen to be exempt from duties at the moment (the final exemption will depend on future discussions). In the end, the measure concerns only 30% of US steel imports.

    Beyond these recent announcements, measures against other sectors of the economy cannot be excluded in the light of the comments made by the US administration. If we take up Donald Trump's dialectics, the sectors most at risk could be those whose utilisation capacity in the United States is currently weak. This would include the textile sector, machinery and computer manufacturing.

  • Measures against imports from China for intellectual property infringement are more problematic. Their extent is still not very clear, even after Donald Trump's press conference. Implemented in one month, they should concern $50 to $60 billion of Chinese products, i.e. approximately 10% of total imports. Sectors that may be targeted are telecommunications products and electronics. Such measure would have a negative impact on the entire technology value chain.

    Possible retaliation measures by the Chinese. Fears of a trade escalation have fuelled fears of a reprisal from China.
    The latter imports little from the United States ($186 billion), and mainly agricultural products (soya bean), cars and aircraft. In response to the press conference on 23 March, China announced import duties amounting to $3 billion on very specific products (wine, fruit, etc.). At this stage, neither soya nor aircraft have been mentioned.  

 

In short, international activities (technology, materials, industrial, automotive) are at risk. The most advantageous industries will be local American players, or foreign players operating on American soil. They will be protected by the new import duties provided that any cost increases (inflation) do not penalise them.

Domestic activities with low export potential, such as banking, utilities and telecoms services, are barely concerned. That said, their performance will also depend on market conditions. Indeed, trade tensions must not call into question the dynamic trend of economic growth, leading to a loss of confidence, slowdown in economic growth, fall in interest rates) which would penalise some of these domestic activities (principally banks).