Global equity markets have been spared the worst effects of increased trade hostility between the US and China so far in 2018, but should the worst of the proposed tariffs be implemented global equity markets could be disproportionately affected by the disruption in supply lines.
This year the US has already, in a first round of tariffs on China, imposed a 25% tax on $50bn of Chinese imports.
On September 17, President Trump announced that the US would impose an additional 10% of tariffs on $200bn worth of Chinese imports, starting on September 24.
He has threatened to hike that further to 25% at the beginning of 2019, and potentially expand into a “phase three” to slap tariffs on another $267bn of imports if China takes any retaliatory actions.
According to Ronan Carr, cross asset and equity strategist at Bank of America Merrill Lynch, the implementation of phase three would mean substantially all Chinese exports to the US would be subject to these tariff increases.
“If we are sitting here in the middle of next year and there are 25% tariffs on up to $517bn of Chinese exports to the US, and in turn China has imposed higher tariffs on imports from the US, the trade effect would be bad,” said Carr. “But the effect on supply chains, corporate confidence and investments would be significantly worse. It could even tip the global economy into a recession.”
Equity markets could be disproportionately affected should trade hostility ratchet up according to Paul Donovan, global chief economist at UBS wealth management.
“Listed companies represent a rather small part of the global economy, but they are a large part of global trade, using crude numbers you would expect listed companies to make up about 25% of the global economy but they are around 80% of global trade.
“That makes equity markets disproportionately vulnerable to trade hostility.”
For equity market investors, and bankers, the threat of trade hostility has so far this year outweighed the actual effects of the new taxes on Chinese goods by the US and markets remain hopeful a settlement can be reached, before the worst potential tariffs are levied.
“Potential trade wars do present an overhang and are a key concern for investors,” said Achintya Manila, head of EMEA equity capital markets at JP Morgan in London. “However, market impact has been limited by the actions being a lot less severe than the political soundbites.
“Current markets are pricing in a level of optimism based on an assumption, that the escalation in noise is only part of a negotiation process that will ultimately result in a more benign settlement.”
“This is supported by economic analysis which suggests that it is possible to reduce the US trade deficit, while limiting the adverse impact on China using tools like currency and measured and targeted reciprocal taxes.”