Long after the election of Donald Trump as President of the United States, the risk of trade protectionism and trade wars have become a key issue for the market, threatening the “Goldilocks” outlook than many investors have for 2018. Why has Trump begun tweeting about trade now and what are his objectives?
The Pennsylvania election
The more immediate trigger was the special election in Pennsylvania, which was called after the resignation of the Republican Tim Murphy. Pennsylvania used to be a significant producer of steel and many residents viewed Trump’s move to place 25% tariffs on steel imports and 10% tariffs on aluminium imports positively. While the tariff threats may have helped the Republican candidate Rick Saccone, he nonetheless appears to have lost the election to the Democrat Conor Lamb.
The market’s initial reaction to the trade protectionism was unsurprising, with US companies expected to benefit from the tariffs gaining 6%-7% in the week following the announcement, and foreign competitors falling by a similar amount (see Exhibit 1). While the price changes appear commensurate, the market may still be incorrectly estimating the gains and losses from the tariffs. The market capitalisation of the US companies has risen by USD 476 million since the tariff announcement, while the loss in value of their non-US counterparts is over USD 29 billion.
Exhibit 1: steel and aluminium indices
Source: Bloomberg, BNP Paribas Asset Management, as of 15/03/2018
Exhibit 2: US trade deficit
Source: Haver, BNP Paribas Asset Management, as of 15/03/2018
Trump’s rhetoric on protectionism
In simple terms, there are two ways to go about this: restrict US imports (for example, via tariffs or quotas), or increase US exports. While Trump’s rhetoric has focused on the former, it is possible his real objective is the later. More exports mean more jobs, certainly a key priority for Trump. Trade restrictions may benefit selected industries, but they will likely hurt the economy overall.
Take, for example, his proposal to impose tariffs on German cars. Taken out of context, it appears another example of protectionism. But the context of Trump’s statement was that Europe places higher tariffs on US exports than the US does on European imports, and that Europe should lower theirs. If not, however, the US could tax German cars.
What Trump claims is partly true. For example, the EU does place a 10% duty on US car imports, while the US duty on European imports is just 2.5%. On the other hand, the US duty on imported European train carriages is 14%, vs 1.7% for US exports to Europe.
These imbalances were all part of the original TTIP (Transatlantic Trade and Investment Partnership) negotiations, which Trump withdrew from soon after he took office.
There have been comments, however, from Trump and other members of his administration that the US could yet re-enter the negotiations. It is possible, then, that Trump’s rhetoric on protectiosnism is simply a negotiating tactic to achieve the tariff reductions he is after and that we will end up with more global trade and not less. If the Europeans can just add another “T” to the acronym, perhaps that will do the trick.
It is not clear, however, that the Europeans will be so accommodating, to say nothing of the Chinese. If relations do deteriorate, which are the countries and sectors most at risk?
It is important to recognise that economic exposure is not the same as equity market risk. For example, Canada is a major exporter of steel to the US, but none of the companies in the MSCI Canada index are steel producers. In fact, of the top 15 countries with the highest share of revenues coming from the US, 10 are European (though some of the US revenues actually come from steel also produced in America).
For the MSCI All Country World index (including small caps), those countries with the biggest share of revenue coming from the US include Canada and Switzerland (see Exhibit 3). Interestingly, China does not figure high on the list. Though China clearly exports a considerable amount to the US, the companies listed in the MSCI China index do not.
Exhibit 3: Share of revenues from US
Source: MSCI, FactSet, BNP Paribas Asset Management, as of 15/03/2018
By sector, those most dependent on sales in the US are healthcare (25% of revenues), information technology (19%) and consumer discretionary (18%). The least exposed (and so most defensive) are real estate and utilities.
If trade tensions do escalate, these countries and sectors are likely to see proportionately greater falls in their equity markets. Relative outperformance of more domestically oriented sectors will likely offer little respite, however, as equity markets would likely decline broadly. Following the imposition of the Smoot-Hawley Tariffs in the US against 20,000 imported goods in June 1930, the S&P 500 fell by 37% through December.
We do not expect things to deteriorate anywhere near so far, but we are certainly aware of the risks. Trump is playing a dangerous game, but if in the end, global trade does increase, perhaps we will say the end justified the means.
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