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#Market Strategy — 18.07.2018

Trade Tensions

Guillaume Duchesne

An analysis of the different announcements

Citing national security concerns, the United States imposed aluminium and steel import duties on its main trading partners in June. President Trump had used the same rationale to launch an investigation on cars imports in May. Furthermore, the US administration has decided supplementary sanctions against China, starting with tariffs of $50 billion on Chinese imports, of which $34 billion already came into effect on 6 July. The remaining $16 billion will probably follow in a matter of weeks. In addition, the US threatened has repeatedly over the last few months additional tariffs on Chinese imports, raising the stakes from $100 billion in April to $400 billion in June. More recently, on 11 July, President Trump upped the ante by announcing that the US would slap a 10 percent tariff on an additional $200 billion worth of Chinese products. He did not mention, however, to what extend this additional threat overlapped with previous announcements. This measure could take effect in October. Overall, around $800 billion worth of imports are threatened or already subject to tariffs, which would represent around one third of US imported goods. So far, implemented tariffs have been limited as they amount to less than $100 billion. Their effect should therefore remain limited and will not hamper global economic growth.

Through these protectionist measures, President Trump clearly wants to put pressure on his trade partners. He has numerous motives. Firstly, Donald Trump is in a hurry to produce visible political results in the run-up to the mid-term elections in November. Secondly, the US administration wants to attack the rise of its main rival, China. To restrain the ascendancy of its main competitor, the US wants to force China to wipe out its trade surplus with it, halt its “Made in China 2025” programme and tackle the issue of intellectual property. Finally, it appears that President Trump is planning to take the US out of the World Trade Organization—the guarantor of multilateral international trade—and negotiate bilateral treaties on a country by country basis, which he deems preferable.

Given the escalating trade tensions, the risks of an alternative scenario in terms of global growth and inflation are rising. However, world economic growth has remained resilient thus far. Investors will need to monitor carefully the confidence indicators, which could be affected by the prospect of a trade war. We expect a bumpy negotiation process, and not a global trade confrontation. 

What’s the impact on the various sectors?

This trade war started with carefully selected goods (solar panels, washing machines) to avoid hurting domestic consumers too much. But it has now escalated and the risks have been extended to various other sectors. The impact of a trade escalation is negative on sales (lower demand) and profit margins (higher prices for imported products). 

For companies, the trade escalation should be negative on their top-line as retaliation measures may have an impact on sales in a large number of countries. Cyclicals are the most exposed sectors. The directly impacted industries are Automobile and Mining. Technology stocks are also affected as their (highly international) chain value may be disrupted by import duties. Industrials are impacted by the risk on capital expenditure. In the event of further escalations in trade tensions, a confidence crisis could be triggered, business and consumer confidence indices would plummet, and finally companies would reschedule investment plans. Such scenario would be clearly disruptive for capital goods. 

Nevertheless, we believe that cyclicals will regain leadership in 2H18 thanks to better economic figures. In addition, companies’ fundamentals are still solid, operating leverage remains favourable and fiscal reform is helping things along in the US. We thus remain positive on cyclicals, except Automobile (more stringent regulation and a mature cycle).  Banks should also benefit from this recovery scenario.   

On the other hand, domestic sectors, Telecom and Utilities, are not directly impacted by protectionism measures as their international revenue exposure is limited. In the current environment, it is tempting to upgrade them as they have underperformed in recent years and are cheap. They however suffer from weak earnings growth and generally underperform during the final phase of each economic and financial cycle. 

Despite a large exposure to global demand, Pharma stocks look relatively immune to the trade war as President Trump has not mentioned tariffs on this industry so far. That said, President Trump is bent on lowering drug prices and could fuel pressure at any time. The pharmaceutical industry remains our favourite defensive sector. It offers solid growth and benefits from cash repatriation to the US, and M&A activity.