Trade War: A game of strategy

trade war

Donald, who?

In early 2016, Parmenion used the incoming US President, Donald Trump as the theme for our regional roadshows. Who was he and what were his plans? We talked about The Wall, his infrastructure plans, tax cutting ideas and the promised support for the military. We didn’t foresee the Russian investigation, high White House staff turnover, children separated from their families, a rapprochement with North Korea or a trade war with China. And it’s the latter issue that is uppermost in the mind of investors today.

Trade Wars: the Soap Opera

There have already been too many twists and turns and third parties unexpectedly enjoined into Trump’s trade war soap opera to summarise on a single page. Calm, unobjectionable Canada has been called out for a good tweeting on its dairy exports. Europe has slapped retaliatory tariffs on Harley-Davidson motor cycles after its steel and aluminium exports to the US were hit. Affected by the same measure, Japan has pushed hard for an exemption. Amidst this flurry of activity, the sense is emerging that the real target is China, and that’s a big issue for investors. A politician needs the support of his own people just at the very end of an election campaign. However, a business needs a long term framework, and a stable planning horizon. And today, business is international.

There have already been too many twists and turns and third parties unexpectedly enjoined into Trump’s trade war soap opera to summarise on a single page.

Chinese trade-away

Trump’s China proposals involve a $34bn package of tariffs, with talk of a much larger target, if there is retaliation. The goal here is to bring jobs home to America, and retain Trump’s blue collar support. The price, even of the threats, is potentially high. China has managed to maintain the strength of its domestic economy since the Financial Crisis. This is in large measure through its banking sector pumping money into housing and construction. This has led to commentators questioning the potential hidden risk a trade war could expose in the stability of Chinese banking.

Parmenion have been wary of overexposure to mainland China as a result. Their government’s response to Trump’s protectionism has been subtle. Their central bank has taken some pressure off the internal credit market. They’ve also adopted a statesman like tone in comments on their external currency and shrewdly targeted retaliatory tariffs aimed deftly at Republican swing states. It looks ominous. But there is another factor influencing markets. The American stock market is seeing a set of storming corporate profit results. They’ve also seen the S&P 500 Index end the quarter strongly, while other markets in the UK and the rest of the world have drifted flatter year to date, see chart below.

stock markets

How sharp are the FAANGS?

There is no doubt that a key factor in driving up US stock markets in the face of mounting trade war concerns, is the rise of the tech giants. Facebook, Apple, Amazon, Netflix and Google (the FAANGS) share a market capitalisation of $2.7trn, as at the end of June, almost the value of the entire UK FTSE 100. The table below demonstrates their rate of share price appreciation and elevated price/earnings ratios. There’s a latent worry that this is DotCom Mark II, a bubble in tech stocks based on naïve expectations of future achievements. The genuine difference is that these businesses have real customers and big profits, here and now.

In the first quarter they shared gross revenue of $187bn and within the numbers is evidence of solid growth. Netflix added a record number of subscribers in Q1, beating all analyst expectations. Amazon returned a record quarter of profitability and Google’s income increased to $31bn in the first three months, against $25bn in the comparable period of 2017. These businesses are driving a global transformation of consumption in news, social interaction, communication, purchasing and entertainment. As are their clones and ‘me too’ followers.

Stock Price $ 52 week high 52 week low P/E ratio Market Cap $bn
Facebook 194.3 203.55 147.8 34.18 466.1
Amazon 1699.8 1763.1 931.75 227.47 824.8
Apple 185.11 194.2 142.41 18.95 909.8
Netflix 391.43 423.31 144.25 279.13 170.1

Source: Financial Times, July 2018

Trumping trade tariffs

Reviewing the financial press at the start of the third quarter, the news of Trump’s increasingly bellicose stance on trade is everywhere. But his personal confidence abounds as he underlined in a recent midnight tweet on 01 July.

 

With the Trump administration’s focus so heavily on a segmented domestic audience the longer term threats to other countries and for US business abroad in his tariff policies seems of no concern. The logic is that the sheer scale of the US economy can be self-sustaining. The economics of ‘beggar my neighbour’, stands to be tested against market sentiment over the rest of this year.

 


The above article was previously published by Parmenion on 13th July 2018