All you need to know about the Trade War

All you need to know about the Trade War


In the past, trade wars have had huge worldwide impacts. Victoria Harris, of Pie Funds, assesses the latest US-China trade war and explains what it means for investors.

When Donald Trump won the US election in 2016, he vowed to ‘Make America great again’.

Since then, Trump started a war with one of the US’s oldest trading partners, China.

The US-China trade war started earlier this year after the US put tariffs on laundry machines and solar panels coming from China. Since then, the trade war has rapidly intensified.

The costs so far

The initial two rounds saw tariffs put on US$50 billion worth of goods from China.

But then it escalated and in the third round, which took effect on September 24, we saw tariffs put on goods worth US$200 billion, affecting US$250 billion worth of goods since the trade war started.

China hit back at the US, saying it would impose tariffs on up to US$60 million worth of US goods, which was a rather meaningless retaliation.

Now Trump has warned even more tariffs could be on the way. If he decides to go ahead with a fourth round, it would mean all of China’s exports to the US would be subject to the tariffs.

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Who are the winners and losers?

Contrary to Trump’s belief, no one wins in a trade war. The losers list is long and widespread.

Those negatively affected include:

Asian export economies. There are many – South Korea, Taiwan, Vietnam, and Malaysia are all vulnerable. These countries export goods, such as machine parts and components for communications equipment, which are used to produce items that China then sells to the US.

US farmers. In particular, soybean farmers will suffer. Exports of soybeans have nosedived since China’s retaliation of tariffs, leaving many US farmers struggling.

Everyday Americans. Some of the top imported products into the US from China are furniture, clothes, toys, and electronics. These will become more expensive.

Those less likely to be affected by the trade war include:

Domestically focused businesses, or those that don’t export. These companies are immune to the tariffs, and they may even benefit, because companies might be forced to source more products locally.

Service or software businesses. These businesses don’t rely on the flow of products across borders, so they’ll avoid costly tariffs in either country.

Countries exporting to the US instead of China. These might include Bangladesh, Turkey, or Vietnam. Garments from China exported to the US will quickly become more expensive. So, US companies will look for cheaper sources of manufacturing, in countries like Bangladesh and Vietnam. Since both countries are now looking to break these trade ties, new countries stand to gain market share.

Demand distributed elsewhere

In most cases though, overall global demand doesn’t really change during a trade war. It’s just reallocated.

So, a reduction in demand for steel from China might result in an increase in demand for steel from other regions. The major beneficiaries of a trade war (or the less affected) are the companies and countries picking up this slack. When there’s a loser, there’s usually a winner on the other side.

But with the US and China being the largest economies in the world, it makes it difficult for smaller nations to fill this supply gap efficiently.

What’s happened on the share market?

Considering China is a net exporter to the US, it’s borne the brunt of the impact. This has been reflected in the region’s share market, which is suffering.

The Shanghai Stock Exchange Composite Index (SHSEC) has fallen 20 per cent since the beginning of the year. The S&P 500 had risen 1.9 per cent (as at 4 November). That’s an approximate USD$720 billion loss for the Chinese economy.

This has led to a stark difference in company valuations between the two countries, as investors pull money out of China.

The Chinese equivalent of the FANGs (Facebook, Amazon, Netflix and Google) are called the BATs, referring to the tech companies Baidu, Alibaba, and Tencent.

The BATs are trading at a 23x forward price-to-earnings ratio, versus a 54x for the equivalent US group. That’s over a 50 per cent discount. And with a country that’s triple the population size of the US, the BATs earnings growth rate should be stronger, and for longer.

What’s the future?

The effects of a trade war are many and widespread, particularly when they’re between two superpower economies. These tariffs are not, yet, on all China exports either, but the impacts have been felt significantly already.

The new tariffs will change the economic fortunes of many nations in the world. The trade war will have several side-effects that are difficult to quantify, and which were not thought through by the Trump administration.

Recent talks between the nations leaders seem to indicate they are moving in a more positive direction. However, I predict that this US-China trade war storm is already in full swing and will not be resolved quickly.

 

Definitions

Forward price-to-earnings ratio: Investors look at this ratio to help them decide to what extent the future earnings of the company are captured in the price. The lower the ratio, the more undervalued the company might be and, theoretically, the more likely its price is to increase.

Standard & Poor’s 500 Index (S&P 500): A market capitalisation-weighted index of the 500 largest US publicly traded companies, across all industries, by market value.

Tariff: Tariffs are taxes or charges imposed on imported goods and services.

Trade war: A situation where countries try to damage each other’s trade, usually through tariffs or quota restrictions.

First published 4 November 2018

Story by Victoria Harris

This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser.  This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.


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