Stock markets around the world could fall by 20% or more and global GDP growth by more than 1% should the US-China conflict become a full-blown trade war, according to economists at UBS.
US President Donald Trump has been ramping up his rhetoric against China, in response to claims of unfair trade practices and theft of intellectual property by the Asian powerhouse. Initial tariffs on the import of $34 billion worth of goods from China to the US had been mirrored by Chinese President Xi Jinping, with many commentators expecting a resolution eventually.
However, this has looked less likely in recent weeks, with the US recently imposing a 10% tariff on an additional $200 billion of Chinese imports to be implemented by September. The US administration is expected this week to announce a further $16 billion in goods to be hit by a 25% tariff.
Current ructions, and the potential impact they could have on markets and economic growth, have worried investors. – and quite rightly, according to UBS economists, who have tried to break down the impact a trade war would have on financial markets.
Stock Markets Could Crash
In their worst-case scenario assumption, where we get a full-blown trade war, US and global growth will fall by 2.45% and 1.08% respectively. The fall-out of this will see S&P earnings take a 14.6% hit and the S&P 500 will sink 21% to 2,200.
Outside of the US, they predict stock markets in Asia excluding Japan could fall by 24%, but European stocks, as measured by the Stoxx 600, could potentially fare worst of all, with a predicted 25% slump.
“Given their higher beta relative to the US, European stock markets could de-rate significantly, despite the fact they already trade at depressed valuations, as investors move away from risk assets and the market loses faith in the sustainability of Europe’s earnings per share recovery,” the economists explain.
On a more macro outlook, the trade war is, of course, inflationary by its nature. Therefore, US and Chinese inflation will rise by 0.7% and 0.9% respectively, with global inflation ticking up by 33 basis points. Growth in China and the European Union is likely to slow by 2.33% and 1.5% respectively.
Elsewhere, UBS predicts markets to re-price Fed expectations, taking out two hikes. The US two-year and 10-year Treasury yields would fall by 50 and 30 basis points respectively.
Of course, this is not anyone’s base case scenario. In fact, most still believe it will not get this far.
Still, in UBS’s two other scenarios, there is damage inflicted upon the economy, stock markets and fixed income assets.
Their first and least-worst scenario sees the already-announced 25% tariffs on $34 billion and the soon-to-be-announced 10% tariffs on $16 billion of goods implemented, with China responding with “roughly the same amount of tariffs”.
While this possibility is already being priced into bond and foreign exchange markets and will hence have little impact on rates and Government bond yields, it will hit other areas.
US – and global – inflation could rise by 5 basis points, with China inflation rising by almost 0.25%. The impact on growth, meanwhile, should be relatively small at 8 basis points for the US and 19 basis points for China. The latter will have a knock-on effect for the European Union, with growth being hit by 5 basis points. Globally, growth will slow by 6 basis points.
It would give the green light to equity markets to continue their march upwards, with earnings per share estimates for the S&P 500 remaining unchanged. UBS’s base case is for the S&P to hit 3,150.
Similar comments apply to the Stoxx 600, which has a target of 440, and the MSCI Asia ex Japan index, which could climb to 790.
Their final, middle scenario, adds 10% tariffs on an additional $200 billion of imports from China as well as on car imports worth $176 billion. China’s response is proportionate, “with a combination of tariff and non-tariff barriers”.
Here, the auto tariffs will have the biggest impact on US inflation. Without them, US inflation climbs by 7 basis points; with them, it goes up by 0.3%. For China, this scenario sees inflation rise by 34 basis points, with global inflation ticking up by 17 basis points.
US growth would also take a big hit – with around 1% coming off the number due to the auto tariffs and the impact it would have on the oil price. For China, the impact would be 67 basis points, but the EU would also be hit hard at around 0.7%. Globally, growth would slow by 42 basis points.
The S&P 500 could slip to 2,500 in this scenario. Earnings for US blue-chips would take a 6% hit, depending on moves in the US dollar and oil. The Stoxx 600 could fall by as much as 7% and earnings would take a 3% hit in 2018 and a further 2% hit in 2019. “Most of the initial impact will be felt by a few sectors such as Autos and Materials.”
In contrast to the falls in US and European markets, the MSCI Asia ex Japan index could move up modestly – by 2% - and test 700.
Yields on US Treasuries would also fall in scenario 2, with the two-year falling by 0.25% and the 10-year by 0.2%. European rates will fall much less in comparison – 5 and 10 basis points respectively. “This is mostly a function of the fact that European rates are already low, and are pricing hardly anything from the ECB during the coming two years.”
Which Stocks Could Benefit or Lose?
UBS’s quantitative team highlighted 10 stocks that could give the best relative performance, and 10 stocks that could give the worst relative performance.
On the lower end of the scale, all of the poorer performers are in the energy sector, with oil likely to take a hit in this scenario. These include US firms like Continental Resources (CLR) and Marathon Oil (MRO), but also Australian company Santos (STO) and some Scandinavian outfits.
Winners are likely to come from the healthcare and consumer discretionary sectors, with Celgene (CELG) and Quarate Retail (QRTEA) in the US named alongside Zalando (ZAL) and Nintendo (7974) globally.
"Given the large move in the oil price, together with the reduction in growth, it is unsurprising that the biggest move would be the underperformance of the energy sector and oil-sensitive markets such as Norway and the UK," says UBS.
