The first shots in a potential trade war have been fired, the International Monetary Fund exclaimed in its latest World Economic Outlook last week. The US-China trade standoff certainly has investors worried, too – and that fear is intensifying.
In the latest fund manager survey carried out by Bank of America Merrill Lynch, 38% of investors said the trade war was the biggest tail risk, up from 30% in March.
That’s no surprise – since peaking in late January, Hong Kong’s Hang Seng has fallen almost 9%. US markets have slipped around 5-6%, too.
The ructions began in early March, when US President Donald Trump announced plans to place tariffs of 25% on steel and other Chinese imports and 10% on aluminium. His counterpart Xi Jinping retaliated by imposing duties on up to $3 billion of US imports.
The episode has continued to escalate, leading Maurice Obstfeld, the IMF’s economic counsellor, to caution that the post-war trading system, which has “nurtured unprecedented growth in the world economy” is now “in danger of being torn apart”.
But are investors right to be so concerned? Mike Bell, global market strategist at JPMorgan, says it’s important to put the figures into perspective. The most aggressive numbers floated are 25% tax on up to $150 billion of goods. That’s $37.5 billion.
“It’s very tricky for us to conceptualise what’s going on when there are numbers in the billions range being thrown around,” Bell notes. In fact, $37.5 billion is 0.3% of China’s GDP in 2017 and 0.2% of the US’s.
In total, exports to China account for just 0.7% of US GDP; exports from China to the US is around 3.6% of China’s GDP. “That does a good job in framing how important this trade discussion is,” Bell adds.
“It’s not that it’s irrelevant; it’s just that the numbers really aren’t big enough to warrant the sort of panic in markets that we’ve seen over the last month or two.”
Both Bell and Chetan Sehgal, manager of Templeton Emerging Markets (TEM), global trade remains robust, and is likely to continue to do so.
How Will A Trade War Impact China?
As for the impact on China, Andy Rothman, investment strategist at Matthews Asia, thinks it will be negligible. “What people have forgotten is that China is no longer an export-led economy,” he explains.
China has successfully transitioned from being an export-led economy to a service-led economy. A decade ago, net exports were equal to 9% of Chinese GDP. Last year, it was equal to 2%. And even within that, exports to other emerging market nations has grown.
Rothman says Trump may have had more success if he had joined forces with the EU and Japan. “That would have been a bloc that was taking 45% of China’s exports – that would have really put some pressure on China.”
Instead, the unilateral approach he’s taking means only 19% of China’s exports are at threat. “A trade war will hurt China, but not as much as people think,” Rothman continues.
Actually, the two countries that would be most affected are the US’s two biggest trading partners, Mexico and Canada. With the North American Free Trade Agreement (NAFTA) currently being re-negotiated, too, Bell thinks the US-China spat is “potentially distracting”.
The biggest risk is that people focus too much on the US-China discussion and don’t focus enough on what is actually the major trade relationship that exists, he adds.
How Will A Trade War Impact The US?
Rothman think it will have more of an impact on the US, though more politically than anything. He says that while Trump is attempting to inflict maximum economic damage on China, China is trying to inflict maximum political damage on Trump.
“It’s actually pretty clever. They’re going after the parts of the US economy that might not be the biggest parts but are the parts that can bring political pressure to bear.”
Take soy beans, one of the products on China’s list of retaliatory tariffs. China imports about 60% of globally traded soy beans. The majority of US farmers’ soy bean crops go to China. Most soy beans are grown in places that vote for Trump.
China’s focus now is on riling the soy bean and wheat farmers – and it’s working. The price of both is down 3.4% and 5.45 respectively in the past seven weeks. “Soy bean and wheat farmers are up in arms and they’re calling their congressmen and saying ‘you gotta talk Trump out of this’,” says Rothman.
Russia’s a Worry
Sehgal says he’s more worried about the impact of trade sanctions on the Russian economy and stock market. The manager says his team curtailed its exposure to companies that derive the majority of their revenues from Russia in the wake of the sanctions to 7.5%.
“This time the sanctions have been impactful,” says Sehgal. “They will have a real impact in the financial markets.” That said, the funds his team runs are overweight Russia due to the oil price tailwinds he sees.
On the sanctions, he says it’s important that the biggest victims of them are not Western investors and that he and his fellow shareholders “have a full, clear visibility as to in what cases sanctions will be imposed”.
This will be helpful “because the uncertainty is driving valuations down in those markets.” Russia's RTS Index rallied 36% to a record high between June 2017 and late February 2018. Since then, it's down 14%.
Will We Have a Trade War?
That brings us to the big question: will these policies be followed through with, or is it all rhetoric? Of course, a large part of the US’s motives is to stop China from stealing its companies’ intellectual property.
Bell likens the tit-for-tat exchanges to a WWE wrestling bout – “an awful lot of talk but not a lot of damage likely to be done”. He doesn’t think there will be a full-blown trade war as it’s in no-one’s interest.
Manraj Sekhon, chief investment officer for emerging market equities at Franklin Templeton, says it’s important to remember that no tariffs have yet been imposed. “Whilst I think it would be unwise for anyone to underestimate what the Trump administration is capable of, I don’t think it is in anyone’s interest for this posturing to turn into something more dangerous,” he says.
Rothman agrees. “This is not about a bare-knuckle trade war and who’s going to win – nobody wins. It’s about putting pressure on Trump to avoid a trade war. My view is that there’s only a 20% probability of a real trade war.
“I believe that President Trump will, before very long, realise that it is in his own personal self interest to sit down a negotiate with the Chinese because every time someone talks trade way the stock market goes down, and he’s very into promoting his success in the stock market.”
Still, odds are the rhetoric, at least, will rumble on. As a result, the stock market will continue to see swings in sentiment, on both sides of the debate. On the Chinese side, the general opinion is that any fall in stock prices will be a buying opportunity.
Most are still bullish on the consumer story in China, and GDP is continuing to grow, albeit not at the rate we’ve come accustomed to in past years.
Sukumar Rajah, manager of Templeton Asian Growth, sees exactly that happening. He sees volatility in the market, but no major disruption to the trading story. “And if volatility caused some of the stocks to go down quite a bit, as bottom-up investors it’s going to give us some opportunities to buy some of these stocks,” he concludes.
