Why the market may be overreacting to tariffs

Andrew McAuley

Credit Suisse

It’s hard to keep track of the latest tariff twists and turns as the US and China battle it out at the negotiating table, but the news is not all bad. In fact, the Australian economy and certain industries may emerge as winners.

To recap so far, it was the US who started the tariff fight. However, the US would argue China have been unfairly treating US businesses for many years by running a closed economy, taking advantage of an open economy in the US, and not protecting US intellectual property (IP). The US argues in some cases China forced the sharing of IP in order to gain access to Chinese markets. Whatever the merits of the arguments, President Trump tweeted on Saturday that the existing tariff rates on USD 250 bn of imports from China will rise from 25% to 30%, effective 1 October. The 10% tariff due to be levied on an additional USD 300 bn worth of Chinese goods in September will now rise to 15%. These retaliatory tariffs come in response to China raising tariff rates by 5%–10% on about USD 75 bn of US imports, due to take effect on 1 September and 15 December. China already has tariffs on USD110bn worth of US exports to China. Amongst all of this, the US and China continue negotiations.

What’s the impact?

In May the IMF suggested that tariffs on all trade between the US and China would subtract 0.3% from global GDP. Not a particularly material number. However, for China itself the hit to Chinese GDP could be 0.75%, and to the US 0.45% of GDP according to the IMF. Again, we would argue a manageable number that would prompt monetary easing and/or fiscal stimulus to counteract. The Fed believes a full 25% tariff would add 0.3% to core CPI, which in the context of currently very low inflation is no reason to expect higher rates in the US. But certainly trade between the two nations has been affected. We saw a drop off in year on year (YoY) growth in total Chinese exports, which has since recovered to be more or less flat. But Chinese exports to the US specifically are still experiencing negative YoY growth.

China Exports Growth – recovery in total exports growth but not to US

Source: Bloomberg, Datastream, Credit Suisse Last data point: July 31, 2019
Source: Bloomberg, Datastream, Credit Suisse 

Last data point: July 31, 2019

Who Are The Winners and Losers?

If we accept at the macro level the tariffs themselves won’t have a material impact on the world economy then why are markets so sensitive to the latest tweet from President Trump either announcing or delaying new tariffs? As we know, markets hate uncertainty, and sentiment is a big mover of day to day markets. That said, just as sentiment can impact investor behaviour, it can impact corporate confidence which may negatively impact corporate investment. Also, weak stock markets can be self-fulfilling, leading to negative impacts on GDP.

Consumers in the US and China are unequivocally losers. The IMF has found that tariff revenue collected has almost been entirely borne by US importers (Impact of US China Trade Tensions, 23rd May, 2019), with importers passing on price increases to consumers. The effects on producers is more mixed. Local companies competing with imports specifically impacted by tariffs have benefitted. But domestic producers using imported inputs are potential losers.

We think there are three ways to take advantage of tariffs. Firstly, favour service companies, it is hard to apply a tariff to a service. Examples include leisure and software sectors. For us, the US software sector is still an attractive short and long term proposition. Also, Australian tourism may benefit as Chinese holiday makers potentially shun the US. Secondly, companies that compete against US companies in China are positioned to win market share. For example Adidas and L’Oreal could win market share off Nike and Estee Lauder. Thirdly, winners are those countries with lowest exposure to manufacturing, lowest exposure to the US and whose exports to China compete with the US. In this case, the Australian economy is set to benefit. We acknowledge our economy as a commodity producer is impacted negatively by second order effects on global manufacturing. However, the US runs a trade surplus with Australia. The Trump administration is incentivised to ensure we aren’t inadvertently affected by tariffs. For example, because of the trade surplus, Bluescope has been able to negotiate an exception to tariffs on the steel it ships to its plant in the US giving it an advantage.

But the real Australian winners are export sectors such as LNG, cotton, beef, coal and any other commodity we produce where the US has been importing or would like to import to China. Although the Chinese may not have applied a tariff yet, the threat is there. But certainly, in the case of LNG, a 25% tariff applies to US LNG but not to Australian LNG. It is difficult to gauge the specific impact so far as it takes time to change supply lines. What we can say is that although the value of Chinese imports has been falling of late, Australian exports which are dominated by China, have been relatively unaffected, helped by healthy prices for commodities such as iron ore.

Australian Exports vs Chinese Imports – Chinese imports lower but no slowdown for Australia

Source: Bloomberg, Datastream, Credit Suisse Last data point: August 16, 2019
Source: Bloomberg, Datastream, Credit Suisse 

Last data point: August 16, 2019

Ironically, the global pessimism being generated by the tariff spat is putting downward pressure on the Aussie Dollar. At the same time, the Chinese are taking measures to stimulate their economy which will ultimately feed into demand for commodities such as iron ore. With costs in Aussie Dollars the large Australian miners look to be in a good position.

The focus on tariffs by markets is justified, but we would argue mostly because of the impact on sentiment. There will be winners and losers. But, taking an unambiguously negative stance on the tariffs dispute is too pessimistic. In fact, the lucky country might be in the right place at the right time. Also, just as sentiment has taken a hit from tariffs, President Trump can easily reverse the tariffs as we approach the 2020 election. With one tweet, he can ensure positive markets prior to polling day. What are the odds of that?

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Andrew McAuley
Chief Investment Officer
Credit Suisse

Andrew McAuley is a Managing Director of Credit Suisse Wealth Management Australia. As Chief Investment Officer, he is responsible for developing discretionary and advisory investment strategies across multi asset class portfolios for clients in...

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