ESCALATING TRADE BATTLE
Watching the intense volleys between Trump and his Chinese counterpart Xi Jinping is like sitting at Wimbledon centre court – except that there can be no winner in the two world leaders’ escalating tit-for-tat trade battle that threatens to engulf the world’s economy.
Trump may have thought he’d served an ace by approving a list of tariffs on US$50 billion of imports from China, with a 25% tariff on US$34 billion of goods effective from 6 July and the remaining US$16 billion imminent. But Xi hit back, promising reciprocal tariffs on US exports. In response, the US president threw down his racquet and threatened to tax a further US$200 billion of Chinese imports.
BIGGEST LOSERS: CONSUMERS
The spiralling Sino-American trade skirmish is likely to have a direct, but limited impact on the growth rate of the world’s two largest economies. Economists have estimated that slapping tariffs on US$50 billion of goods in both directions would knock between 0.1 and 0.3 percentage points off China’s gross domestic product (GDP) growth, the figure for the US being slightly lower at between 0.1 and 0.2. However, including the US$200 billion tariff proposal could lower US GDP growth by around 0.3 percentage points, and may also impact US companies with investments in China.
Needless to say, ordinary consumers will be the big losers in the game of brinkmanship between Trump and Xi. US companies that source technology and electronic components from China will likely respond in one of two ways: depending on their pricing power, they’ll either take it on the chin and endure a margin squeeze to absorb higher input costs, or they’ll pass these on to their customers. The former option will of course adversely impact profits – which explains why equity markets have been particularly negative on some IT stocks over the past few weeks.
All things being equal, it’s been estimated that if the current trade proposals are implemented, consumer price inflation in the US is likely to rise by about 15 basis points (bps). Since it’s currently running at 2.3%, this shouldn’t be too troublesome for equity markets, however.
IMPACT ON BUSINESS CONFIDENCE
Of greater concern than the direct consequences of Trump’s trade war at macro level is the indirect effect we’re already witnessing on business confidence in the economy – especially around investment decisions. Where companies are uncertain about trade relationships, they’re likely to postpone new capital expenditure. Also, if firms start feeling the pinch in profitability, they may shift their operations to more favourable geographies – a case in point being motorcycle manufacturer Harley-Davidson, which has announced it will move some production out of the US.
Stalling business confidence resulting from trade fears will be a further blow for the global growth story, which is already looking long in the tooth. The synchronised economic recovery across geographic regions of the past few years has for various reasons started to lose momentum since January – and the Trump-Xi trade impasse, as well as the US president’s protectionist stance toward Canada and Europe among others, couldn’t have come at a worse time. Global economic expansion was partly the result of a vibrant trade environment, so in the current slowdown, increasing trade tensions are only adding further risk.
WHERE TO FROM HERE?
There appear to be two schools of thought as to how the current confrontation will play out. One holds that despite the escalating spat, pragmatism will win out in the long run – that the main protagonists will realise the futility of what are hopefully mere strong-arm tactics and sabre-rattling, and that it’s a stand-off no one will ultimately win.
Over the past few weeks we’ve seen, however, that neither side seems willing to back off. And given Trump’s notorious unpredictability, there’s a real risk that the showdown will continue and even intensify. If this happens, it may well contribute to ending the global economic upcycle and equity market bull run we’ve enjoyed over the past years.
Our base case scenario is that sanity will ultimately prevail and global policymakers will act rationally. But there can be no doubt that the reputation for recklessness of one of the main players in this game of chicken over global trade will result in tensions remaining elevated at least over the short term, with increased uncertainty, negative business sentiment and diminished confidence putting the brakes on economic growth globally.
IMPLICATIONS FOR INVESTORS
What does all this mean for investors? The tariff saga is likely to have a direct impact on investments in global businesses – especially tech companies – that rely on component parts made in China: increasing input costs could materially sting their bottom lines.
However, it will indirectly hurt South African markets as well. If global equities catch the flu, our bourse also sneezes – increased volatility across international markets resulting from negative sentiment and reduced investor confidence will undoubtedly spill over to local stock markets.
While there’s no question that Trump’s trade war has increased the risks associated with equities and other risk assets, it should be remembered that globally, equity prices have already come off the boil. And in South Africa, the market has to a large extent priced in the negative noise.
POSITIONING PORTFOLIOS
Macro uncertainties such as those created by Trump’s tariff tiffs will always affect investor sentiment over the short term. The important thing to note is that when you’re uncertain about the future, you don’t position your portfolio as if you’re certain. In our view, a balanced approach is therefore appropriate for long-term investors.
It should be clear that from an equity perspective – both offshore and local – now is not the time for aggressive investment positioning. We’ve therefore reduced our exposure to this asset class in our balanced portfolios.
However, equities will always have an important place in a longer-term investment strategy – they remain the core building block of any inflation-beating portfolio. In the local equity market, value is now starting to emerge, and buying decent-quality shares should provide a buffer to the uncertainties created by the events playing out at global level.
The bottom line is that while the economic impact of the mounting trade tensions is undoubtedly significant, history has demonstrated that periods of uncertainty always create opportunities for long-term investors. We won’t hesitate to put our cash positions to work when we identify these opportunities.
