All eyes on trade

11 min read 6 Jun 19

Summary: In this month’s video, Investment Director, Ritu Vohora looks at the escalating trade war between the US and China, with tensions reducing risk appetite and intensifying fears of a global economic slowdown.

In contrast to the first four months of the year, returns were negative across all regions in May. Japan fell the least during the month while the S&P500 Index saw its biggest slump since 2010. The US remains the only major region to outperform the global index year-to-date. Emerging markets performed worst over the month, weighed down by China, while India was the best performing, following the successful re-election of Prime Minister Modi.

Investors sought safety in gold and highly-rated government bonds including US 10-year treasuries, sending prices higher and pushing down yields. In the most notable example of a ‘flight to safety’, Germany’s 10-year bund yield fell as much as 2.6 basis points to minus 0.202% — its lowest level on records that stretch back to the reunification of Germany in 1990.

In US dollar terms, all sectors finished the month in negative territory. Technology, especially semiconductors and tech hardware, fared worst, alongside energy, as the hardest hit sectors. In a defensive rotation, real estate, utilities and healthcare fell the least.

Festering US-China trade tensions have reduced risk appetite and stoked fears of a global economic slowdown. Tensions escalated in May after US President Trump slapped fresh tariffs on US$200 billion worth of Chinese goods, triggering retaliation from China. Conflict between the two countries has centred on technology and largely on Chinese telecoms giant Huawei.

There is unlikely to be a resolution to the trade war before a G20 summit in Japan in June. A surprise threat of tariffs on Mexican goods from President Trump, in an effort to curb illegal immigration, will further disrupt global trade flows. Hot on the heels of the renewed NAFTA trade agreement, this suggests the pact negotiated by the US with Mexico and Canada is not worth the paper it’s printed on. For China, the question is whether any future deal will be honoured. A broader worry is which country is next on Trump’s tariff list – it would not take much for the dispute with Europe to resume.

With integrated supply chains, few countries are safe from a global trade war. The escalation has added to worries that a global tariff war could hit economic growth, not only in the US and China but also in major European economies including Germany and France. The eurozone is most at risk from trade disputes – with over 50% of company revenues coming from overseas, and Germany is the most exposed to US and China trade.

So why is President Trump continuing with tariff threats? It could be a populist endeavour, emboldened by a strong US economy, to act tough towards China. With the 2020 presidential election on the horizon, Trump will be keen to keep his electorate on side. He is also acutely aware of China’s ascent as a superpower; a trade war might be an effective way to slow that down.

China is becoming a global economic superpower to rival the US. 1 in 5 people on the planet now are Chinese, and China is expected to account for 33% of global growth in 2019, compared to just 11% for the US. The economy will soon rival US economic supremacy – back in 2015 the Chinese economy was just 20% the size of the US economy, versus over 65% now. China’s economic and technological supremacy may also be causing Trump to worry about its growing military prowess.

Tariffs can significantly change the cost of doing business. The more the tit-for-tat spats endure, the more that higher input costs will hit consumers and corporates. Many companies absorbed the first 10% tariffs imposed in September, but new tariffs may force them to shift strategy, for example moving purchases to other countries or having to raise prices – hurting consumers’ pockets. If price increases can no longer be passed on to customers, company margins will take a hit, lowering profitability. Sectors with the highest revenue exposure to China include technology, consumer discretionary, materials and industrials.

Ultimately, both sides will want to reach some kind of deal. With tariffs already in place, and the risk of these being increased, the stakes are now higher than in 2018, for both sides. While the impact on global growth so far is relatively modest, this could change if the tariffs imposed escalate and broaden further. Any escalation could dent business and market sentiment, delay investment decisions, disrupt global supply chains and adversely impact company margins. Taking an active approach that focuses on the longer-term fundamentals of individual companies, with resilient business models, will be key to help navigate the uncertainty.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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