Managing Director and Head of Equity Research
Bank of Singapore
Member of OCBC Wealth Panel
Protectionist signals coming out of President-elect Trump’s camp are a cause for concern. Unlike many of his pre-election slogans, he has shown no signs of backing away from a hostile trade policy, in terms of both appointments and his Twitter feed.
Moreover, the U.S. president has significant authority when it comes to trade agreements and tariffs, so changes can be made without going through Congress.
Meanwhile, global equity markets have buoyantly dived onto a reflationary trade even as the Republican’s sweep has widened the range of possible global growth and geopolitical outcomes. While it would be highly negative for Asia’s growth if Trump pursues his anti-trade policies, investors currently do not seem too concerned.
China will be the focus of any U.S. anti-trade policies. But given the highly connected intra-Asia as well as US-Asia trade links, it is unlikely that any of the Asian markets would go unscathed if the situation turns ugly.
Protectionism involves big risks to the U.S. and Asia
The focus on China is easy to understand as it accounts for more than one-third of the overall U.S. trade deficit. The imbalance with targets such as Mexico, Japan and Germany is one-fifth the size of that with China. It might be China’s surplus, but it affects all of East and Southeast Asia, as so many production networks use China as the final assembly point before exporting to the U.S. Therefore, it is unlikely that any of the Asian markets would go unscathed if the situation turns ugly on the trade front. By sector, office equipment, machinery and automobiles are the biggest imports by the U.S. China accounts for the bulk of the office equipment and machinery imports. Japan and Germany are the biggest exporter of automobiles to the U.S.
Asia (including Japan) – No one is safe
Majority of the countries in Asia runs a trade surplus with the U.S. The notable exceptions are Hong Kong, Australia and Singapore. Besides China, Japan and Korea would be most directly impacted by trade barriers from the U.S.
Perhaps more importantly, given the highly connected intra-Asia trade links, trade barriers on China would affect the whole region. Coupled with potential impact of faster-than-expected U.S. interest-rate normalisation and currency vulnerability, we remain underweight on Asia ex-Japan.
China – More technology (hardware) than industrial exposure
With office equipment (including electronics) representing a 27 per cent of Chinese exports to the U.S., a potential trade war with China would have negative impact for the Chinese technology sector.
In particular, we see hardware players as most vulnerable to a trade war.
Japan – automakers are exposed
For Japan, its automotive companies are the most exposed to U.S. anti-trade risks, given that autos accounted for a substantial 35.9 per cent of the country’s imports going into the U.S. in 2015.
With respect to NAFTA, Trump’s trade concern has been more directed at Mexico, where various global and Japanese auto companies have set-up manufacturing plants primarily producing vehicles meant for the U.S. market. Currently there is no duty levied on autos within NAFTA. If the U.S. raises duty on auto imports from Mexico, it will impact earnings of firms that import vehicles into the U.S.
Hence, should a higher tariff materialise on U.S. imports of autos manufactured in Japan, all manufacturers will be impacted. This may also lead the auto companies to consider adding capacity in the U.S., which could add to costs.
With fair values already exceeded following the recent equity market rally and trade related uncertainties rising, we are cautious on the near term outlook of the Japanese auto sector.
Europe – Mixed exposure for German autos
In Europe, Volkswagen is the most exposed to potential US-Mexico trade wars with over 80 per cent of North America production coming from Mexico. Fiat-Chrysler could potentially see some earnings impact from higher tariffs with 36 per cent or production outside of the U.S.
Relative to the other European automakers, BMW and Daimler look best-positioned for a potential increase in import tariffs on vehicles into the U.S., with almost all North America production done within the U.S.
U.S. – Action and reaction
Benefiting from the reflation trade, valuations for U.S. equities have extended further. Even though U.S. companies could benefit from growth enhancing domestic policies from the new administration, those with significant sales to Asia, such as U.S. technology and industrials, would be adversely impacted by any retaliatory actions.
If U.S. protectionism undermines North American Free Trade Agreement (NAFTA) and the World Trade Organisation (WTO), and provokes a response from trade partners, then the world can descend into a trade war. Reversing the globalisation of recent decades would raise costs, hurt productivity and even risk worldwide recession. China’s response will be key, as its economy looks vulnerable, but it is not a good candidate to be bullied, so it could retaliate.
With machinery and transport equipment contributing to 45 per cent of total U.S. exports to Asia, the U.S. technology (hardware) and industrial sectors could bear the brunt of retaliatory actions in the event that trade wars between the U.S. and Asia escalate.
Meanwhile, U.S. industrial stocks have rallied following the Republican sweep in the hope that business friendly infrastructure spending and corporate tax reform from the new administration would boost growth, not just domestically in the U.S. but also globally.
Our investment views for the week:
- Donald Trump’s election victory should be viewed as a new global shock, mixing positive demand and negative supply elements. There remains considerable uncertainty about the actual mix of policies to be enacted.
- Since it is too early to extrapolate Trump’s economic policies, it is best to view Trumponomics in 3 scenarios: the good, not so bad, and ugly
- The “good” scenario is the current world we live in, but with the addition of Trump’s fiscal thrust and big deregulation. The ugly scenario is one in which Trump tries to expand fiscal policy resulting in more inflation than growth. In the “ugly” scenario, there is limited deregulation to spur growth and Trump has to go on trade wars to steal growth elsewhere. The “not so bad” scenario is the more probable and our baseline outcome – in between the 2 extremes - with moderate fiscal policy and some deregulation.
- The broader ramification of Trumponomics is that it creates fatter tail outcomes - either very good or ugly - which translates into higher uncertainty and wider ranges for asset returns.
- In our base case –”not so bad” scenario, bond returns could come mainly from coupons with little capital appreciations. EM bond returns of 10-15 per cent in 2016 cannot be repeated in 2017.
- Under a “not so bad” world, expected equity returns may be bond-like with some compensation for equity risk premium. Hence, investors need a more diversified portfolio. An all-bond portfolio, especially an over-concentration to EM bonds, may not work as well for 2017. With Trump’s focus on energy deregulation, we are becoming less bearish on Developed Market High Yield bonds.
- It’s not all doom and gloom. Trump’s uncertain world creates equity winners & losers. In our base case, the U.S. would outperform, while the rest of the markets register lacklustre returns. Therefore, on our equity region allocation, we are turning cautious on the U.S. from an underweight position.
- In 2017, there will be heightened uncertainty with several key risk events. Markets will be watchful of Trump’s key appointments and as he unveils his economic policies. The Fed is likely to hike rates for a second time, which has been priced into the markets as almost a certainty.
- The new year also promises to be a highly political one. President-Elect Donald J. Trump will take office on 20 January 2017. In Europe, the Dutch, French and Germans will go to the polls and in March, the Brexit negotiations are set to begin.
- We continue to advocate a defensive posture for asset allocation. This does not mean that there are no investment opportunities; instead investment strategies have to be more nimble to adjust along the way as we get more clarity on what Trump will do.
- Prepare yourselves for Trumponomics, we are now living in a brave new world!
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