Investors are becoming more concerned that trade tensions could disrupt global supply chains, slow global growth, and result in higher prices for businesses and consumers. T. Rowe Price managers are evaluating the potential impact on various sectors and companies, and some have modulated portfolio positions given heightened risks.
The Trump administration’s aggressive efforts to extract more favorable terms for existing trade agreements have raised concerns about the potential disruption of global supply chains, higher prices for businesses and consumers, and slower global growth.
These challenges to global trade pacts have prompted T. Rowe Price portfolio managers to closely monitor trade discussions to assess potential impacts on sectors and companies. Some managers have modulated some portfolio positions given heightened risks, but as of the end of September, they generally had not made significant adjustments—due to the uncertainty surrounding the trade negotiations.
Managers believe the new trade policies are not likely to derail the U.S. economic expansion, which has seen U.S. equity markets reach new highs this year, but they believe market risks have increased.
As of the end of September, President Trump had imposed tariffs of USD $250 billion on a wide range of imported goods from China, prompting retaliation from the world’s second-largest economy and the United States’ largest trading partner. He also was considering tariffs on an additional USD $267 billion of Chinese imports, which would cover almost all of China’s exports to the United States.
In turn, China added tariffs on USD $60 billion of U.S. exports to China, putting its total tariffs on USD $110 billion worth of goods. Last year, China imported USD $130 billion of goods from the United States.
In March, the United States also imposed 25% tariffs on steel imports and 10% tariffs on aluminum imports from various areas, including the European Union, Canada, and Mexico, as well as on various consumer and industrial products—prompting global retaliation.
Construction accounts for about 48% of U.S. steel consumption, and autos account for 29%. If passed on, the steel and aluminum tariffs could raise prices in the United States and abroad for a wide range of other manufactured goods, including other types of vehicles, beverages, and kitchen appliances.
U.S. and China Equity Market Performance in Year of Rising Trade Tensions
Relative Price Performance in 2018 indexed to 100 as of December 31, 2017
As of September 24, 2018
Past performance is not a reliable indicator of future performance.
Trade restrictions have had more impact in China. However, the recent drawdown in Chinese equities is as much a reflection of slowing domestic growth rates as it is the trade wars.
Sources: Goldman Sachs Investment Strategy Group, Bloomberg, and FactSet.
Meanwhile, the Trump administration has reached a temporary truce with the European Union and a revised North American Free Trade Agreement (NAFTA) with Mexico and Canada that is expected to relieve pressure on the auto industry supply chain in North America.
The revised NAFTA agreement would require automobile companies to manufacture at least 75% of an automobile’s content in North America, up from 62.5% currently, and with higher-wage workers to qualify for NAFTA’s zero tariffs. But congressional approval remains uncertain.
David Giroux, chief investment officer of U.S. Equity and manager of the Capital Appreciation Fund, says that four groups of companies may be affected by the tougher U.S. trade policies:
- U.S. and foreign importers and exporters directly penalized by U.S. or retaliatory tariffs, such as U.S. agricultural exporters to China
- U.S. companies exposed to non-tariff retaliation by China if a trade war escalates, such as multinational companies with business in China that are large U.S. employers and have political influence—notably, Apple, General Motors, or McDonald’s. Retaliation might include boycotts or legal and regulatory actions
- U.S. companies that do business in China and that don’t have a lot of foreign competitors or political influence and so have less risk—unless U.S. tariffs cause the Chinese economy to suffer
- Sectors and companies that could benefit if trade tensions escalate because they might be viewed as defensive investments, such as U.S. utilities; “They don’t have any operations in China, and if the economy here slows, that could mean lower interest rates, which is good for utilities,” Mr. Giroux says.
China and U.S. Exports as GDP* Share
As of June 30, 2018
Sources: China National Bureau of Statistics, U.S. Bureau of Economic Analysis, Haver Analytics, and T. Rowe Price.
*Gross domestic product.
Larry Puglia, manager of the Blue Chip Growth Fund, is encouraged by the agreements in progress with the European Union and Mexico and Canada. “Pursuing fairer trade terms is desirable but entails certain risks,” he says. “It would be premature to make investment decisions that assume successful resolution of these issues. We’re doing the math to determine what’s at stake.”
Over decades, large U.S. companies, particularly manufacturers, have developed extensive global supply chains, relying on worldwide sources of lower-cost production. Higher component costs due to tariffs could bring higher inflation over the long term, says Peter Bates, manager of the Global Industrials Fund. “But companies would eventually learn how to maximize their returns under the new rules.
“Tariffs undermine globalization, and the potential downside of being less globalized is higher prices, but that could lead to less reliance on foreign labor and more production being brought back to the United States,” he says. As a result, Mr. Bates is focusing on companies that sell valuable products “that aren’t commodities—as they can raise prices to offset higher costs.”
U.S. steel companies U.S. Steel, AK Steel, and Steel Dynamics have benefited from the 25% tariff on steel imports. Bradlee Kilgore, the firm’s steel analyst, says tariffs have increased U.S. steel prices from USD $600 to USD $900 a ton this year. Imports have dropped from 25% of the U.S. market at the start of this year to about 15% to 20%.
While a short-term boon, tariffs “longer term could do more harm than good because they might exacerbate the eventual downcycle,” Mr. Kilgore says.
If tariff-driven price increases lead to a U.S. economic slowdown, stocks in discretionary consumer sectors, such as clothing and leisure travel, could underperform, but those in more defensive areas, such as food, likely would be less exposed, says Jason Nogueira, manager of the Global Consumer Fund. He recently has increased his exposure to stocks of certain discretionary companies that could be more resilient in a slowdown.
“The reality is if all the proposed tariffs go through, that would be fairly negative for the economy and the markets,” Mr. Nogueira adds. “Just about every company has global supply chains that could be affected—plus there would be secondary and tertiary effects. It’s very difficult to calculate all the possible permutations and consequences.”
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The views contained herein are those of the authors as of October 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
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