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 more immediate trigger was the special election in Pennsylvania last week, which was called following of the resignation of the Republican, Tim Murphy, who previously held the seat. 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 equity market’s initial reaction to Trump’s tariff tweet was unsurprising, with American 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 Figure 1). While the price changes are balanced, the market may still be incorrectly estimating the gains and losses from the tariffs. The market capitalisation of the US companies has risen by $476 million since the tariff announcement, while the loss in value of their non-US counterparts is over $29 billion.
Figure 1: Steel and aluminium indices
Data as at 15 March 2018. Sources: Bloomberg, BNP Paribas Asset Management.
Now that the Trump administration has opened the door for further exemptions from the tariffs beyond Canada, Mexico, and Australia, many European producers may find the damage to their share prices is overdone.
Trump’s broader objective, however, has always been to reduce the US trade deficit, which he perceives to be an indicator of American economic weakness (see Figure 2).
Figure 2: US trade deficit
Data as at 15 March 2018. Sources: Haver, BNP Paribas Asset Management.
In simple terms, there are two ways to achieve this reduction: 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 him, whereas trade restrictions benefit only selected industries yet hurt the economy overall. Take, for example, his recent proposal to impose tariffs on German automobiles. Taken out of context, it appears another example of protectionism. But Trump’s full statement was that Europe places higher tariffs on US exports than America does on European imports, and that Europe should lower theirs. If not, however, the US could tax German autos.
What Trump claims is partly true. For example, the European Union does place a 10% duty on US auto imports, while the American 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 American 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 that Trump’s rhetoric is simply a negotiating tactic in order to achieve the tariff reductions he is after, and that in the end we will end up with more global trade and not less. If the Europeans can just add another “T” to the TTIP acronym (for “Trump” of course), perhaps that will do the trick.
It is not clear, however, that the Europeans will be so accommodating, to say nothing of the Chinese (please see the article “A looming trade war? Implications of Sino-US frictions” by our Senior Economist Chi Lo). 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 equity market risk. For example, Canada is a major steel exporter 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, ten are European (though some of the US revenues actually come from steel produced in America).
For the MSCI All Country World IMI index (which includes small caps), those countries with the biggest share of their revenue coming from the US include Canada and Switzerland (see Figure 3). Interestingly, China does not figure high up in the list. Though China clearly exports a considerable amount to the US, the companies listed in the MSCI China index do not.
Figure 3: Share of revenues from US
Data as at 15 March 2018. Sources: MSCI, FactSet, BNP Paribas Asset Management.
By sector, those most dependent on sales in America are health care (25% of revenues), information technology (19%), and consumer discretionary (18%). The least exposed (and so most defensive in the case of a trade war) 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 decline broadly. As a reminder, following the imposition of the Smoot-Hawley Tariffs in America against 200,000 imported goods in June 1930, the S&P 500 fell 37% through December of that year.
We do not anticipate things will deteriorate anywhere near so far, but we are certainly conscientious of the risks. Trump is playing a dangerous games, but if in the end global trade does increase, perhaps we will say the ends justified the means.