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Which equity sectors could win in a US-China trade war?

02 July 2019

Charles Schwab UK managing director Richard Flynn considers which sectors would be the winners and losers in the US equity space in the event of an all-out trade war with China.

By Richard Flynn,

Charles Schwab

US-China trade tensions have so far seemed a little like a game of volleyball – with the US serving an increase in the tariff rate, and the Chinese returning with their own rise. The ball is currently in the court of the US, with another tariff increase under consideration.

The dispute has heated up in recent weeks and there appears to have been some distinct sector market moves since the 6 May Tweet from president Donald Trump that dashed hopes of a near-term trade deal. Amid the uncertainty, investors will no doubt be wondering which sectors will over and underperform until the tensions are resolved. Although historical performance is certainly no guarantee of future performance, it can give us a clue as to where the next market winners, and losers, might be.

Sector performance since trade tensions heated up

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Defensive sectors have performed better, while the more economically sensitive groups have struggled. That makes sense, as the more friction is put in the world’s trade gears, the stronger concern becomes that global economic growth may be hurt.

Additionally, there is a remarkable correlation between the level of foreign exposure and recent sector performance. According to Strategas Research, the utilities and real estate groups have a mere 3.1 per cent and 14.1 per cent respectively of their revenues from foreign sources, while the tech group has a much higher 57.8 per cent of their revenues attributable to foreign sources.

 

Deal

Investors anticipating a deal between the US and China might consider allocating to sectors which have been punished the most. Although no sector should ever be looked at through a single lens, it seems likely that a deal and the reduction of trade tensions would result in at least a short-term reaction by investors rushing into those areas that have been hit the most, such as tech, industrials, and consumer discretionary. It is worth noting that this argument does not so much apply to the energy sector, as there are other geopolitical and economic issues that appear to be affecting its weakness.

However, it might behove those investors who believe a deal is imminent and are comfortable taking on a bit more risk to start adding to positions in these sectors in order to benefit from a possible deal-related spike, with the understanding that until a deal is signed, those areas could continue to struggle.

 

No deal

There is also the possibility that the trade dispute continues to escalate and drags on for months or years. This outcome is potentially more complicated for investors. In the short term, it seems likely that the recent trends will continue, and those sectors with more domestically oriented businesses will likely outperform.

But there are also less obvious impacts that are possible as well. For example, the economic growth concerns associated with trade tensions have pushed US Treasury yields lower. As a result, mortgage rates have moved lower, helping homebuilders, which are in the consumer discretionary sector, outperform.

Moving a little longer term, the calculus may change as companies look to adjust their suppliers or markets in an attempt to avoid the trade tensions. For example, FootwearNews.com has a list of recent quotes from retailers noting that they are moving some production out of China. The chief executive of J.C. Penney noted that the company has been able to “significantly reduce our exposure to China,” while Brooks Running, a subsidiary of Berkshire Hathaway, announced that it was moving production out of China to Vietnam. Meanwhile, there are reports that Apple is moving production of its MacBook and iPad products to Indonesia.

These changes are likely to provide some company or industry-specific opportunities in the longer term, even if a deal remains elusive. For those investors who are willing to bet on the no-deal scenario lasting for a while, there is likely still time to potentially benefit from adding to positions in such areas as utilities and real estate.

 

Proceed with caution

Any outcome could impact a variety of sectors in different ways and there are myriad factors to consider when looking at how the US-China trade war impacts investing. This is part of the reason why we have a diversified, relatively neutral, although modestly defensive, overall sector stance at present.

It’s impossible to tell when, or if, a deal will be forthcoming between the US and China. The situation can change quickly, as we saw last month with a mere Tweet. We strongly recommend to those investors who want to make bets one way or the other: don’t go overboard and stay diversified so you have some level of stability against any potential market volatility.

 

Richard Flynn is UK managing director at Charles Schwab. The views expressed above are his own and should not be taken as investment advice.

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