No one has to worry about a looming trade war anymore. It’s real, and its consequences are better and worse than feared. The stock market hasn’t crashed. It even gained a bit during the first week. But the Midwest is in misery.
There’s a lot for investors who want to step away from trouble or capitalize on the uproar to watch.
On July 6, US President Donald Trump imposed tariffs on $34 billion of goods. China immediately reciprocated with tariffs on US soybeans, aircraft, chemicals, and autos in a slightly more forceful $50 billion market punch.
That was just the opening skirmish, but some effects were immediate, and they showed most starkly in Midwestern agricultural enterprises. Soybean prices plunged as farmers saw their most important market suddenly pull out of reach. On July 11, soybean prices hit a 10-year low.
It’s an object lesson that the White House is not heeding, because “trade wars are easy to win” according to the president. But even the damage in this first round of tariffs could be more than temporary. If the US government wanted to be sure that Brazil and Argentina would displace the US as a soybean powerhouse, a 25% tariff would be the perfect tool. The industry was already under pressure. Brazil surpassed the US in soybean exports to China in 2013. Thanks to the new tariff, Brazil and Argentina will probably build on that lead for the long term. US farmers may never regain their pre-war viability in this market.
Now we brace for another round as investors and businesses try to figure out what happens next.
$200 Billion Buys A Lot of Pain
Since China retaliated against his first round salvo, Trump has put another $200 billion in Chinese imports on his hit list. He’s made it clear that he’s not accepting anything but an abject submission from China, which he blames for America’s loss of factory jobs and trade imbalances.
Trump’s next round of goods will have a lower rate, 10% tariffs as opposed to the 25% tariffs he levied on his first round. But the effect is wider and full of risk for both countries.
One reason that China needs to fight back is that Trump’s list is calculated to prevent China from increasing its export power in industries with greater profit margins. That’s because many of the items Trump has targeted are part of China’s ambitious “Made in China 2025” plan.
In that initiative, China is supporting a handful of advanced manufacturing industries with large investments, subsidies, and research. The plan’s intent is for China to become 70% self-sufficient by 2025 in fields such as information technology, robotics, aviation, automated machine tools, maritime equipment, hi-tech shipping, new materials, pharmaceuticals, and new energy vehicles.
This potential is a greater threat to the US economy than current and past trade imbalances. China’s success as a high-tech exporter would directly undercut some of the US’s most valuable industries—industries that now sell more to the Chinese than the Chinese sell in the US.
The Made in China program along with China’s infrastructure building to reach trade partners in Asia, Europe and Africa, called the China Belt and Road Initiative, could rewrite global the Who’s Who of global trade in the next decade. For all its huge trade volume, China is still behind other developed countries in advanced goods. Much of what it exports are basic items like shoes, clothes and toys.
The Trump administration contends that Made in China 2025 violates World Trade Organization (WTO) rules. That issue is now under review at WTO. As one of the world’s four largest trading economies, China’s trade is formally reviewed every second year. Hearings on July 11 to 13 indicated that the US does not believe WTO has the tools to control China. Or so the president claims.
But if Trump intends to hold China back, his tariffs are doubtful ammunition. The US accounts for only 18% of China’s export trade according to economist Kristen Hopewell who has extensively studied world trade and the WTO. In her opinion, the Trump tariffs will be negligible in stopping China from increasing its trade power.
Invest in Non-importers and Losers
Meanwhile, back in the US, manufacturers are bracing for much bigger shocks. China’s retaliatory tariffs have largely targeted materials and goods that US businesses depend on. Harley Davidson became the poster child for the backlash when it announced it was moving some manufacturing to Mexico thanks to the Trump tariffs.
Investors have some time to consider the implications of the likely next round of tariffs. Public comments on the subject will continue through August 30 before final action is taken.
The administration has further promised that it will be generous in helping industries win exceptions if they need it.
That promise and Trump’s past behaviors make it hard to guess which specific companies might thrive or falter under a full-scale trade war. Case in point, ZTE, which the Commerce Dept. barred from doing business with US companies after it had sold sensitive components to Iran and North Korea then lying about it. The seven-year ban was all but a death sentence for ZTE, clearly a Chinese company adding to our trade imbalance. But instead of applauding, Trump intervened with a promise to protect ZTE.
So where can investors go with so much still unknown?
Try the non-combatants—companies that don’t export or depend on imported parts.
One such company that might ride through the storm unhurt is Coca-Cola (KO). That’s because the company uses local bottlers around the world, so imported supplies are not an issue for it. Other fairly safe bets are companies with 100% of their business in the US and no imported materials or parts needed—for instance, Public Storage (PSA).
On the other hand, investors who watch for deep values or options traders who buy companies they covet with naked puts at low prices could be the biggest winners.
A trade war is a blunt and clumsy weapon. While some businesses, like growing soybeans in the great American Midwest, are sure to take a hit, the big damage will be broader in scope. Waiting to buy companies you admire at lower prices can be a powerful strategy to capitalize on the uproar.
And there should be plenty of uproar ahead.
The CNBC Global CFO Council, which represents companies that manage more than $4.5 trillion in market cap, recently surveyed its members on their attitudes. Two-thirds of them believe the trade war will be negative or very negative for their businesses.
For value hunters, that’s a lot of potential.