We have now seen actions, rather than just rhetoric, on U.S. China trade in a broad sense. While it will take markets some time to fully and appropriately price in the impact, it was encouraging to see markets not react too poorly to the first round of tariff implementation last Friday. However, it is likely that this was a case of investors simply treating all trade scenarios as “no new news is good news,” which is not sustainable in the present environment. As we saw over the last 24 hours, U.S. application of tariffs on Chinese goods is not a one and done event, the U.S. will continue to try and apply tariffs across a broad range of Chinese goods.
The U.S. China trade dispute—we would dispute calling it a war, empirically we are far from what would be called a trade war—is something investors need to be paying attention to as it is far from over, and the impact will be global. The majority of the value in the imports from China the U.S. has imposed tariffs on so far comes from other countries besides China—refracting their impact around the world, but scaling down the damage on any one market. For equity markets, over the past 18 months, a protectionist trade announcement has corresponded to a 30bps fall in S&P 500 total return on the day of announcement, followed by a 1ppt. cumulative recovery over the subsequent five trading days*. Onshore Chinese equities have taken new developments much worse, as trade has provided a knock to sentiment in an already challenging market environment. Investors’ initial reaction to trade developments, as with most situations, is sharp and then investors take a breath and refocus on what drives returns—which in this time of rising trade tensions is a much more individual company specific question than it once was.
U.S.: Never happier than when in a fight
The U.S. actions this week remind us of fighting with a sibling when we were little; they dyed one of our rabbits pink, figured in for a penny, might as well be in for a pound, then threw away our science fair project. The U.S. applied tariffs on a large amount of Chinese exports and then, before the effects of China’s reaction could be felt, proposed tariffs on another $200B.
The U.S. has announced tariffs on $250 billion of Chinese imports so far this year—and threatened tariffs on an additional $300 billion of imports. The process of applying these tariffs—25% on $50B and 10% on $200B—will take time. The investigation that provided the legal justification for the U.S. administration to apply these tariffs in the first place began almost a year ago and any proposal must allow time for public comments; this is why the tariffs applied on July 6 were on $34 billion of imports, not $50. The public comment process scales these proposals back a lot. The new proposal for 10% tariffs on $200B of imports will allow for public comments until August 30, meaning the earliest they could go in effect is September 1—right when fall campaign season kicks off.
So far, the U.S. has done everything possible to try and limit the direct impact to consumers. In the initial $50B proposal, the impact fell far more on businesses than consumers. The vast majority of tariffs fell on goods that companies would reasonably use in capex projects or intermediate goods in the production process, meaning that any resulting rise in inflation will take time to reach consumers. The revisions to the tariffs proposals between April and June moved even more in this direction.
Sources: PIIE, USITC Dataweb, J.P. Morgan Asset Management.
From a U.S. market’s perspective these tariffs have highly differentiated effects across production lines and the distribution of these tariffs does not fall evenly across sectors. U.S. companies will be some of the most hurt by these tariffs as the intermediate goods the U.S. will now charge a tariff on are the intermediate goods in the production processes of many U.S. firms.
Tariffs are not evenly distributed across sectors
Source: U.S. Census Bureau, U.S. Department of Commerce, U.S. Trade Representative (USTR), J.P. Morgan Asset Management. Analysis incorporates full year 2017 U.S. dutible imports data across the 8,461 individual HS tariff lines the USTR has published for public consultation and groups items into industries (GICS) by most common use at the two digit HS level.
*“What is a trade war and are we in one?” by Benjamin Mandel and Hannah Anderson, J.P. Morgan Asset
**Section 301 of the U.S. Trade Act of 1974 gives the U.S. president the power to take action to protect companies or industries subject to unfair practices by a foreign government, “that burdens or restricts U.S. commerce.” In the 301 action against China, the U.S. Trade Representative instigated an investigation to, “determine whether acts, policies, and practices of the Government of China related to technology transfer, intellectual property, and innovation are unreasonable or discriminatory and burden or restrict U.S. commerce.” For more information: USTR Announcement: https://ustr.gov/about-us/policy-offices/press-office/press-releases/2017/august/ustr-announces-initiation-section.