Is the market “buying” the trade war news?

By Brian Tycangco

There's an old market saying: Buy the rumour; sell the news. That is - you buy in anticipation… and sell when the possibility becomes reality.

But in the case of the ongoing trade war between the U.S. and China, for some markets it's been a case of "sell the rumour"… and, potentially, buy the news.

Let me explain.

How the markets have reacted so far

Earlier this month, we talked about (here) how Asian markets have so far reacted to the brewing trade war since it officially began on March 22, 2018. That's when U.S President Donald Trump announced tariffs on US$60 billion worth of Chinese goods coming into the U.S.

In the six months since then, there's been clear evidence that the trade war has had little direct impact on either economy. Exports and imports continue to rise, particularly in China. Manufacturing activity, although growing slower, is still growing.

But investors have been selling Chinese stocks in anticipation of more tariffs given Trump's repeated threats to tax practically every single remaining Chinese export finding its way to U.S. shores. China's Shanghai Composite Index has fallen 23.4 percent in the last six months.

Investors have also been dumping shares in markets that have a strong link to China's export manufacturing supply chain, including Vietnam (down 16.7 percent), Singapore (down 11 percent) and Hong Kong (down 10.8 percent).

Cheap doesn't mean it's over

On Tuesday, the Office of the U.S. Trade Representative announced it will be slapping 10 percent tariffs on US$200 billion worth of Chinese exports beginning Monday.

But instead of the markets falling on the news, they went up. The S&P 500 gained 0.5 percent, Shanghai's stock index rose 1.9 percent, and Hong Kong's Hang Seng Index jumped 1.2 percent.

With many of Asia's stock markets now trading near their lowest levels in 12 months, and other markets are looking cheap… perhaps the bad news is finally out and nothing else worse could happen, right?

No… bad idea.

Things will get worse before they get better

Nobody wins in a trade war. We've written extensively about what the consequences of the trade war could bring (see here, here and here).

Moreover, the global supply chain means that everything is connected. An iPhone sold in California is assembled in a factory in China. It contains components that are shipped from manufacturing plants in Vietnam, Cambodia, Taiwan and Singapore… which source inputs from other countries like China, Vietnam and the U.S.

Yes, China has a lot more to lose in a trade war with the U.S. It exports goods worth US$530 billion a year to the U.S., while it imports just US$187 billion. So China's scope to retaliate is, by definition, limited.

But the Chinese government isn't rolling over. According to the Wall Street Journal, some Chinese officials are now advising Beijing to restrict sales of materials, equipment and other parts vital to U.S. manufacturers' supply chains, which likely includes the all-important consumer electronics industry.

In addition, a lot of American and U.S.-listed companies earn a significant share of their revenue from China directly. For example, Apple generates 20 percent of its revenue in China. Tech companies including Qualcomm, Micron Technology and Broadcom all derive at least 50 percent of their revenue in China.

This means that apart from the limited number of U.S. exports that Beijing can target with tit-for-tat tariffs, it can also strangle the substantial China-based operations of U.S. companies, small and large.

The trade war will likely get worse. And as the market anticipates what trade ammunition will be used in the next exchange of attacks, there will be more "selling on rumour".

What you should do

In this uncertain environment, keeping to the sidelines and not doing anything is always an option. There's always that urge to act, especially when you see prices trading at their lowest levels in more than a year and you think that you're getting good value. Resist it.

Defensive stocks will also continue to outperform. That's because defensive stocks, by nature, are generally immune to the cyclical nature of business. These include stocks in the energy, utilities and telecommunications sectors, where demand remains fairly constant although slow-growing.

Over the last six months, for instance, Asia's energy sector has far outperformed all other sectors, with a 6.2 percent gain.

As shown in the graph below, the utilities and telecommunications sectors have also done well relative to the overall bearishness in Asia-related equities, both hardly unchanged since the trade war began.

So, once again, with the trade war far from over, the markets and sectors that have done well and poorly over the last six months will likely continue their trend. As I mentioned here, the Australian and Indian markets have outperformed… as have the energy, utilities and telecommunications sectors.

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