President Trump’s increasingly strident rhetoric on trade has once again manifested itself into concrete actions; the imposition of import tariffs on aluminium and steel. Whilst exemptions have been sought by and granted to the United States’ principal trading partners, namely the European Union, Mexico, Canada and Australia, assuaging concerns that a global trade war was imminent, the President’s subsequent announcement to impose tariffs on $60 billion of Chinese imports reignited these fears, with global equity markets declining as a result.
Whilst emerging market equities have performed strongly over the past year, with the MSCI Emerging Market Equity Index returning c18% (in local currency terms), many investors are concerned that the imposition of trade protections could have a significantly negative effect on these economies and depress output, as net trade is often the largest contributor to their GDP growth. Emerging market equities and currencies sold off significantly as news broke of the US President’s plans.
At the end of last year, China, the principal target of President Trump’s ire, had a $375 billion trade surplus with the United States. This makes China more exposed should a trade war break out and may explain China’s more conciliatory tone of late. With c37% of its GDP derived from trade, the imposition of import tariffs is likely to have a direct, albeit contained, effect on Chinese growth (its direct vulnerability to trade shocks has declined over the past decade).
Many of the proposed tariffs are targeted on the Chinese aerospace, technology, and industrial machinery sectors, impacting only a relatively small portion of Chinese exports to the United States. However, the transitionary effects of supply chains are likely to permeate the impact throughout the wider economy; for example, depressed demand within those sectors targeted by trade tariffs would induce less demand for their primary inputs.
Retaliatory measures, including the imposition on import tariffs on a range of US produced goods as varied as aircraft, cars, soybeans and pork, have already been threatened by the Chinese authorities, raising concerns that tensions could escalate further.
However, ongoing meetings between the Chinese and American authorities have seen a preliminary deal signed which would see China purchase hundreds of billions of dollars’ worth of additional US exports, as well as opening its market to US agricultural, energy and financial products.
In addition, the early signs of rapprochement between the United States and North Korea, with President Trump and Kim Jong-Un set to meet in Singapore in June, could be indicative of a further de-escalation, with any meeting between the two leaders likely to have been sanctioned by the Chinese authorities.
Despite the initial concerns, given the detrimental effects that both economies would face should additional protectionist measures be imposed and the recent conciliatory actions, a further escalation is unlikely. However, should the global economy become more isolationist and less open to trade, reduced business investment and financial market volatility would likely depress investor sentiment.
When news of President Trump’s trade sanctions initially broke, equity markets, in particular emerging market equities, declined as investors feared the repercussions of a material impact on trade and economic growth. The extension of exemptions as well as the conciliatory actions of the Chinese authorities have eased concerns, with equity prices recovering somewhat. We have maintained our ‘Green’ outlook for Emerging Market Equities; valuations remain attractive, economic data is strong and corporate earnings robust. However, caution is warranted given the dependency of emerging markets on international trade, with the outcome of the ongoing negotiations between the US and China crucial.
Matt Tucker, Investment Analyst, Quantum Advisory.
