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Investors can win the trade war

09 May 2019

Constructive economic data reports, consensus-beating corporate earnings and accommodative central banks have encouraged investors that the fundamentals remain in place to support the rally in risk assets seen this year.

Volatility has been falling and clients have been implementing strategies to take advantage of late-cycle opportunities, partly on expectations that many of the dark macroeconomic clouds that have been overhanging markets will dissipate through the year.

US-China trade fears

In the era of social media, the geopolitical complexion can rapidly change. President Trump’s 5 May trade tweet sent a shockwave through financial markets (China’s CSI 300 index fell 5.8%). The tweet forced analysts to question the assumption that a peaceful resolution to the trade war between the US and China was inevitable.

The intervention came as an unwelcome surprise for investors after a barrage of reports in recent weeks, from supposedly credible sources, claiming that tangible progress has been made on many key areas on the negotiation.

As we know, the US has been pushing China to buy more of its products, open up its markets to US companies, relax its rules on the forced transfer of technology and protect intellectual property rights.

President Trump, buoyed by solid domestic growth data and the backdrop of the 2020 presidential election campaign, said: “The trade deal with China continues, but too slowly as they attempt to renegotiate. No!”. He threatened to increase existing tariff rates and impose new levies on a broader range of exports from China. China is the world’s largest exporter- it exports around $2 trillion each year, $600bn of which is bound for the US.

Effect on growth

Clearly the implementation of higher tariffs would significantly impact China’s growth profile. We estimate that a 25% tariff on $200bn of China’s exports would drag down gross domestic product (GDP) expansion by 30-50 basis points over a 12-month period, with exports down by 3-5 percentage points.

An additional 25% levy on the remaining exports could reduce China’s GDP growth by another 0.5%. Although, in this worst case scenario, we would expect Chinese authorities to try and mitigate the impact by increasing fiscal and monetary policy support while allowing its currency to depreciate.

The US is not immune from an escalation of the trade dispute. Trade wars push up consumer and producer prices, thereby reducing demand for products and services and increasing costs for US businesses.

Trump protectionism is a risk for global growth

Investment implications

Our base case scenario is that economic pragmatism will eventually prevail. This in turn should facilitate the slow removal of tariffs and reduce trade and policy uncertainty. Should the sell-off in equity markets deepen it could be a good entry point for an asset class we think will outperform in the medium term. Investors should consider combining US exposure with secular growth opportunities in emerging markets.

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