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Are trade tensions the only thing to look out for in stock markets?

12 July 2018

How trade tensions can be a distraction from the fundamentals that matter for stock markets.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • How a US-China trade war will impact stock markets.
  • Why the risk of a US-China trade war remains low.
  • How fears of a trade war can distract investors from the still-healthy fundamentals that drive the stock markets.

The world’s political leaders continue to do their utmost to wrench the world’s gaze from knock-out football. Resignations, trade threats and power grabs continue to vie for the front pages of mainstream media. For investors, the dust thrown up by these various scuffles is helping to obscure a still-improving backdrop for companies. Our strong hunch remains that this dust will settle before too long, rewarding those who continue to lean portfolios gently towards stocks in both emerging and developed worlds, as we are.

The latest on trade

A fresh round of tariffs between the US and China were imposed last Friday. Further tariffs have been threatened, though these could take a while to materialise. Many have already pointed out that the direct effect of these tariffs is likely to be small. To us, the main threat is of further tit-for-tat escalation between these two economic giants.

However, the other point to consider is that the last several decades have seen supply chains integrate in a way that makes the kind of surgical trade war being advertised much harder to prosecute. In the critical categories of technology, industrial and capital goods, and electrical equipment, about a third of US imports come from US company affiliates operating in China, for example (reference Empirical). Industrials, particularly car manufacturers, is the sector that stands out based on the international nature of both its revenues and input costs. If our faith in the presence of the midterm elections in the US as a moderating influence proves misplaced, the suffering will be wider and will surely incorporate all risky assets, including those traded in the US.

For the moment, we still do not see sufficient cause to take evasive action in portfolios. Midterm elections are important, particularly with Congress so finely balanced between the Democrats and Republicans, according to latest polling. We still see economic and political self-interest forcing an eventual de-escalation, but we are braced for capital markets to be dragged in to play an increasingly disciplinary role as the skirmish continues to escalate in the short run.

Profits rising

Context is vital. The important context for investors, particularly those interested in stocks, is that the underlying fundamental backdrop continues to improve. The next US and global recession does not look imminent, based on the indicators that we look at. Indeed, last week’s readings were encouraging, with the US Institute for Supply Management (ISM) manufacturing index rebounding to healthy levels, US nonfarm payrolls in June remaining in line with this year’s average employment gains, and the European Purchasing Managers Indices (PMIs) showing tentative signs of recovery. Some of this health could be a caused by firms front-loading their production activity ahead of tariffs. However, the broad nature of the ongoing recovery in global demand should give us some reassurance as we try to peer through the dust storm. We expect this economic vitality to be again showcased by another round of healthy profits from companies on both sides of the Atlantic. Admittedly, this already rosy cheeked health has been supercharged temporarily by US tax cuts, but the underlying trend in profitability for the global corporate sector remains intact in our view.

Investment conclusion

Within Continental Europe and Emerging Asia, two regions we favour within our portfolio allocation, profitability continues to improve and analysts are brightening on the earnings prospects of companies. A full-blown trade war will obviously hurt those trends, however for those assuming, like us, that this remains possible but far from probable, the improving bigger picture is the most important thing to focus on.

These are our current opinions but the future, as ever, is uncertain and past performance of investments is not a reliable indicator of future performance. The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

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