Trade war a threat to growth, but some sectors offer a cushion

Trade tension has been making headlines for the past few months and seems to have been escalating recently. The causes, however, have deep roots.

Globalisation has evolved and broadened over the past several decades, benefiting western consumers, emerging market manufacturers and the global economy.

It has helped pull millions out of poverty and significantly strengthened the ranks of the global middle class. Yet the benefits of globalisation have not been distributed evenly. Blue-collar western workers, who have seen their jobs sent overseas and have struggled to adapt to the new economic landscape, have felt understandably disaffected by globalisation.

The financial crisis of a decade ago didn’t help; nor did the policy response, which succeeded in generating the asset price inflation investors had sought but failed to generate the wage inflation workers longed for. Protectionism has therefore been rising in developed markets and has found expression in the US under President Donald Trump’s America First slogan.

Protectionist policies, however, rarely deliver on their promises in the long run.

Trump’s announced tariffs targeting a long list of goods — including steel, aluminium, solar panels and home appliances — are part of a protectionist trade stance that also includes the US withdrawal from the Trans-Pacific Partnership and an ongoing investigation into China’s intellectual property practices.

From June, the office of the US trade representative has targeted more than 1,000 Chinese products, which are valued at about $50bn.

The tariffs are set to be imposed in phases and mainly focus on the key industrial products and technologies that are tied to China’s Made in China 2025 initiative.

The levying of tariffs is not a new feature of US trade policy; every president since Jimmy Carter has imposed some kind of protectionist curbs on trade, often targeting steel. Nor will many of Trump’s tariffs do much economic damage in isolation; the most prominent — on steel and aluminium imports — would only reduce US GDP by 0.2% annually in the short term.

Forms of retaliation

What is new about these measures is their context. They come at a time when the US is turning inward, away from its long-held role as champion of free market capitalism, international co-operation and other tenets that define globalisation.

What makes this moment especially dangerous is the heightened potential for more worrisome forms of retaliation, particularly from China, at a time when President Xi Jinping is striving to present an alternative to US values and hegemony.

The real risk is that the tariffs introduced thus far are just the opening salvo in a full-blown multilateral trade war affecting the global economy. Perhaps the greatest tinder box in this potential conflict is intellectual property rights in the technology sector. An investigation by the US trade representative into China’s intellectual property practices concluded in a 2017 study that Chinese theft of intellectual property costs US companies up to $600bn annually.

An escalating trade war between China and the US implies rising prices for consumers and a likely acceleration in inflation, putting upward pressure on interest rates. Overall, it would probably result in both countries becoming less prosperous and secure.

Tariffs are not the only protectionist measures that the US has taken. Earlier in 2018, Congress introduced a bill aimed at stopping the government from doing business with two Chinese telecoms companies (though Trump has since defended one of these companies’ access to the US market). Trump also took the unusual step of blocking the takeover of a US memory chip maker by a Singaporean competitor, citing national security concerns.

While the risk of an escalating trade war is a clear negative for global growth and co-operation, the knock-on effects of higher inflation and rising interest rates could conversely help cushion value-orientated stocks from the adverse consequences. That is because value stocks are often concentrated in sectors that are sensitive to interest rates and inflation, including financials and commodities.

Low interest rates

Value stocks have underperformed growth stocks for 10 out of the past 11 years, marking one of the longest and deepest bear markets yet for the style. A major cause of value’s woes has been artificially low interest rates, which have distorted the value of money and forced investors out of the risk curve in search of growth and yield.

The normalisation of US interest rates could support value-orientated stocks and other late-cycle beneficiaries, such as the financial and energy sectors and European markets.

European markets tend to do well late in the cycle due to their high exposure to inflation-and rate-sensitive sectors such as commodities and financials.

European companies have been vastly underearning their US peers while trading at historical valuation discounts. They are therefore offering scope for both profit improvement and multiple expansion as policy conditions normalise.

Overall, the risk of an escalating trade war is a net negative for global economic growth and equity market prosperity.

While value portfolios appear to be relatively well positioned for a late-cycle environment of rising interest rates, escalating trade tension nevertheless remains a cause for concern among global investors.

• Boersma is with Templeton Global Equity Group