Trade tensions between the U.S. and China, the two largest economies in the world, continued to pose a threat to the performance of global capital markets over the last year and a half. The U.S. was first to enact tariffs on $50 billion worth of Chinese imports, to which China retaliated within a few days. Below is an illustration of how the trade war has escalated so far since mid-2018.
Source: Reuters.
As a result of bilateral discussions between the representatives of the two parties, it was announced last Friday that the U.S. and China have agreed to a phase one trade deal. Whether this marks the end of the trade war is up for debate, but clearly, the success of this agreement will have a significant impact on market performance over the next couple of years.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Phase one trade deal in summary” data-reactid=”27″>Phase one trade deal in summary
According to the statements issued by the Customs Tariffs Commission of the State Council (China) and the U.S. Trade Representative on Friday, the following terms were agreed to in this deal:
- The U.S. would not proceed with 15% tariffs scheduled to go into effect on Dec. 15 on approximately $160 billion worth of Chinese goods.
- China agreed to suspend the planned tariffs scheduled for Dec. 15 on some U.S. goods.
- The U.S. will reduce the tariff rate imposed on $120 billion worth of Chinese goods to 7.5% from 15%.
- Tariffs already imposed by both the countries on each other would remain unchanged.
- China will import $200 billion in additional American goods and services over the next two years on top of the amount it purchased in 2017.
- Improved intellectual property protection for American technology in China.
The deal will be signed in the first week of 2020.
President Donald Trump confirmed these successful negotiations on Twitter on Friday, uplifting the sentiment of investors around the world.
Source: Twitter.
In the remainder of this analysis, the impact of this deal on investors will be discussed with a view of identifying companies and industries that stand to gain the most.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="The U.S. trade deficit with China will shrink” data-reactid=”48″>The U.S. trade deficit with China will shrink
Over the plast decade, while China emerged as a global economic superpower, the trade deficit of the U.S. with China grew to record highs. As evident from the below graph, negotiations with Chinese officials over the last three years have not improved this situation.
Source: Statista via the United States Census Bureau.
China, not surprisingly, is in a position to produce goods at lower costs than America due to low labor costs and a highly efficient workforce. American companies have found it difficult to compete with these cheap products, which eventually prompted the decision to move their supply chain operations to emerging countries, including China and India. This could lead to a higher unemployment level in the U.S. in the long term, and hence was one of the main reasons why many economists highlighted the need for improving the trade position with China.
The additional $200 billion worth of American goods that China will be buying over the next two years will certainly help bridge this gap and provide a boost to investor sentiment about the prospects of the American economy in the next couple of years. Overall, this positivity should translate into a better capital market performance.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="The global economy is expected to receive a boost” data-reactid=”60″>The global economy is expected to receive a boost
Global economic growth highly correlates with the performance of equities. There is reason to believe that trade negotiations will help create a platform for the global economy to continue expanding over the next several years. According to estimates of the World Economic Forum, released to the public via a research report published on Nov. 1, a further escalation of the trade war would lead to a permanent loss of 4% of gross domestic product for the European Union and 3% for the United States. The Asia-Pacific region was also expected to take a massive hit. This analysis went on to claim that the perceived benefits of trade tensions will prove to be temporary in nature and that there would be no winners, only losers, in the long term.
Below is an excerpt from the report published by the World Economic Forum.
“It would be short-sighted to declare the (short-term) beneficiaries of trade tensions winners, since they too are affected by dangers for the global economy as a whole. Such dangers can particularly result from uncertainty. Businesses planning to enter into new markets or already conducting international business are likely to decrease their investment activity. In the US, for example, tariff worries caused 30% of manufacturers and 25% of goods producers to reassess their capital expenditure plans in 2018. International trade flows in intermediate goods may be affected disproportionately in response to uncertainty shocks. Uncertainty may also lead to risk reassessment, reducing investment and potentially hindering productivity.”
The phase one trade deal will likely put an end to the risks highlighted here, providing a boost to global economic activities. Companies around the world will feel more at ease in investing in new projects, which should drive economic output on a global scale. These are all positive signs for capital market investors.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Winners of the trade deal” data-reactid=”71″>Winners of the trade deal
With China agreeing to buy more American products, there are a few business sectors that appear to be in a prime position to benefit. The agriculture sector is one of them.
China has always been a top importer of U.S. farm products, and in 2018 accounted for $5.9 billion of such purchases.
Source: U.S. Census Bureau.
The retaliatory tariffs by China were beginning to take their toll on agricultural exports from the U.S. According to John Newton, the chief economist at the American Farm Bureau Federation, the demand for soybeans from China dropped by about 80% in 2019, which is expected to decline even further if the trade war escalates.
In line with the agreement by Chinese authorities to purchase more U.S. products, including farm products and related equipment, Caterpillar Inc. (NYSE:CAT) could benefit immensely. For the 12 months ended on Sept. 30, China accounted for 5.1% of company revenue, ranking in the third position from a geographical perspective. Shares of Caterpillar might receive a boost along with increased purchasing activities in Asian countries.
Tyson Foods Inc. (NYSE:TSN) is also worth a look at as China is the world’s largest market for pork products. Fewer barriers to trade may help this multinational giant stand out from the local competition.
The technology sector will also reap the benefits of this trade deal, as many U.S. tech companies depend on revenue from China. The below table illustrates the companies with the highest revenue exposure to China as of October.
Source: Goldman Sachs/ CNBC.
Investors might want to consider semiconductor stocks once again. Micron Technology Inc. (NASDAQ:MU), Nvidia Corp. (NASDAQ:NVDA) and Intel Corp. (INTC) could turn out to be winners in the next year as trade tensions subside.
The automotive sector is also prime for a recovery as the sentiment turns positive. Germany’s Center for Automotive Research previously estimated that trade tensions would cost the global car industry an estimated $770 billion over the next five years in lost sales. This prompted many investors to stay on the sidelines due to fears that U.S.-listed automobile stock would receive a pounding. However, things may now change for the better as the increasing disposable income around the world should lead to higher vehicle sales. Tesla Inc. (NASDAQ:TSLA) and Daimler AG (DDAIF) are two companies to look out for as both these manufacturers have big plans for China and the Asian region.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Emerging market funds could be the biggest winner” data-reactid=”96″>Emerging market funds could be the biggest winner
While companies and sectors identified in the previous segment of the analysis will likely receive a boost from trade war resolutions, emerging markets might provide the best investment opportunities for investors. Over the last five years, the S&P 500 Index has performed much better than emerging equities as measured by the performance of the iShares MSCI Emerging Markets Index (EEM).
The trade war was one of the primary reasons for this underperformance. In August, Business Insider reported that investors are fleeing emerging market stocks at the fastest pace since 2015 due to tariff fears. The crippling effect of such protectionist policies, however, is set to come to an end when the U.S. and China sign the phase one trade deal. This has the potential to create a good platform for Asian stocks to provide stellar returns, and the low-interest-rate environment in most emerging market countries will also help the cause.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="In an article published last month, I highlighted that legendary investors, including Ray Dalio (Trades, Portfolio), are betting big on emerging markets, which is another reason for investors to pay close attention to investment opportunities in these regions.” data-reactid=”112″>In an article published last month, I highlighted that legendary investors, including Ray Dalio (Trades, Portfolio), are betting big on emerging markets, which is another reason for investors to pay close attention to investment opportunities in these regions.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Takeaway for investors” data-reactid=”113″>Takeaway for investors
Trade tensions proved to be a challenge for investors throughout the last one and half years. However, the tables are finally set to turn as the U.S. and China near a deal. There could be many winners from this development, including business sectors such as agriculture, semiconductor manufacturing and automobiles. Investing in emerging market exchange-traded funds could also generate alpha returns in the next couple of years.
While things mostly look promising, investors need to factor in the risk of a last-minute fallout from either one of these parties as well. Officials from both the U.S. and China have historically been reluctant to reach a middle ground, and there’s always the possibility of a further escalation of tensions. Therefore, prudent investors should try to diversify their portfolios among different asset classes, industries and countries while trying to benefit from the present most likely outcomes.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Disclosure: I am long the iShares MSCI Emerging Markets Index.” data-reactid=”116″>Disclosure: I am long the iShares MSCI Emerging Markets Index.
Read more here:
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="This article first appeared on GuruFocus.
” data-reactid=”124″>This article first appeared on GuruFocus.
Add Comment