Global Investment

Put option, adequate diversification to cushion trade war impact

The tariffs slapped by the US on China, and with China retaliating, have caused jitters on global share prices. Apart from addressing the US$375bil trade deficit with China, the move has also incentivised President Trump to deliver his campaign pledges with the tariffs acting as a bargaining strategy for key voting states in the US mid-term election in November.

If the trade war continues extensively, it might have some knock-on effects on global GDP, though we may not want to overstate these at this stage. Apart from the US and China, we also need to observe Japan, Mexico and Canada as they are the key trading partners of the world’s largest economies, focusing on trade policies specifically in areas of automobiles and auto parts, electronics, petroleum products, and electronics and machinery.

We foresee equities facing the biggest hit as corporate earnings, especially from the cyclical sectors most exposed to economic swings, will likely face strong selling pressure. Companies which account for a large portion of global production chain of Chinese exports i.e. the US, South Korea, and Taiwan will be affected. Japan’s equity market will remain jittery due to the strong importance of exports in driving GDP and also a stronger yen, which is deemed as a safe haven currency, will make its exports more expensive. Selling pressure remains on China and Hong Kong markets. European and S Korean markets will be less impacted since they are included in the exemption list alongside Argentina, Australia and Brazil but they may still be less attractive as investors seek a safe haven.

Malaysian market will also be caught in the jitters given that exports play a crucial role in driving the GDP and concerns on companies involved in the global supply chain production of the Chinese exports. From our technical analysis, the immediate note suggests more of a sideways trading pattern in the local stock market with the KLCI hovering between 1,838 and 1,881 points. Should the market surpass the 1,881 level, the next resistance is anticipated to be at the historical high of 1,896. However, if the market dips below the 1,838 level, the next major support is at 1,795 with the psychological mark at 1,700.

We feel that investors who seek to cushion their portfolios against the risk of a full-scale trade war should ensure that they are not overexposed to export-oriented equity regions or sectors that are highly dependent on global supply chains as these will be hit by a combination of rising input costs due to tariffs, and possibly also supply restrictions.

We suggest investors to have adequate global diversification, including assets in the US where some sectors could benefit directly from the tariffs e.g. steel manufacturers. They should consider equity put options to reduce portfolio volatility. Put options are financial instruments that give traders an option to sell assets at an agreed price on a particular date, thus allowing traders to hedge their portfolios

• Global stock markets took a hit from a broad selloff. In an echo of the early February slump, global share prices came under pressure as President Trump slapped tariffs on China in retaliation for supposedly stealing US technology with tariffs of US$50bil. China retaliated by revealing plans to apply tariffs on 128 US products. This raised the prospect of an all-out trade war between the world’s two largest economies.

• The implementation of the tariffs may help address the US$375bil trade deficit with China. US exports to China is about US$130bil, while China’s exports to the US is around US$506bil. Our estimation shows the potential loss of Chinese GDP is about 0.2%.

• Besides, we believe with the US mid-term election in November, it incentivised President Trump to deliver his campaign pledges since tariffs acts as a bargaining strategy for preferential trade that could prove popular in key voting states. The US president has ordered the Office of the US Trade Representative to propose a list of product tariff increases and consider further tariffs on goods from China, while the US Treasury prepares a plan to further sanction Chinese investment in the technology sector. These moves follow the announcement of 25% tariff on steel and 10% on aluminium earlier in the month.

• The underlying fear is that the growing trade tension might have some knock-on effects on global GDP. Although we may not want to overstate the direct impact of these tariffs on the global economy or equity markets at this stage, we do recognise the potential damage to global growth, paying particular attention to tariffs that target non-agricultural goods.

• In addition to the US and China, we also need to observe Japan, Mexico and Canada as they are key trading partners of the world’s largest economies. Our concern is when the policies enacted by these large economies specifically target trade in areas like automobiles and auto parts, electronics, petroleum products, and electronics and machinery.

• Besides, we foresee equities facing the biggest hit. In particular, we expect corporate earnings, especially from the cyclical sectors most exposed to economic swings, will likely face strong selling pressure. Tariffs tend to raise prices for consumers, raise costs for businesses using imported materials in manufacturing, and marginally detract from economic growth. It can produce no winners.

• We believe companies who have a significant portion of global production chain of Chinese exports will be affected i.e. the US, South Korea and Taiwan. Japan’s equity market will remain jittery due to its large exports that play a vital role in driving the GDP and a stronger yen, which is deemed as safe haven currency, that will make their exports more expensive. Selling pressure from the Chinese and Hong Kong equities remains.

• The Euro equity markets should be less impacted given that they are now included the exemption list alongside Argentina, Australia, South Korea and Brazil. Still, we believe European and South Korean markets will be caught alongside jitters from investors who are looking at safe havens.

• We believe the Malaysian market will also be caught in the jitters given that exports play a crucial role in driving the GDP. Concerns will be on companies involved in the global supply chain production of the Chinese exports.

• From our technical analysis, the immediate note suggests more of a sideways trading pattern in the local stock market with the KLCI hovering between 1,838 and 1,881 points. Should the market surpass the 1,881 level, the next resistance is anticipated to be at the historical high of 1,896. However, if the market dips below the 1,838 level, the next major support is at 1,795 with the psychological mark at 1,700.

• We feel that investors who seek to protect their portfolios against the risk of a full-scale trade war should ensure that they are not overexposed to export-oriented equity regions or sectors such as machinery, car manufacturing and retail industries. The reason being these are highly dependent on global supply chains. The result is bound to be a combination of rising input costs due to tariffs, and possibly supply restrictions. In turn, they should ensure adequate global diversification, including assets in the US where some sectors could benefit directly from the tariffs e.g. steel manufacturers

• In our view, levying tariffs on various tech services and software can be tough. Fabless manufacturing essentially is the outsourcing of actual chip production to third parties, usually in Asia, often by US-based semiconductor companies that do their own design and development work. The US-based tech companies have limited domestic alternatives for sourcing their chips and hardware, much of which is produced in Asia.

• A trade war ultimately may push up US interest rates, which, in turn would allow banks to increase their profit margins. Tariffs will weaken the dollar. With foreigners holding about 42% of the outstanding US Treasury securities, a falling dollar will reduce their returns when translated into their own currencies. Thus, those foreign creditors will demand higher interest payments to compensate for the falling dollar. China may cut back on its purchases of US government bonds.

• We suggest investors to have adequate global diversification, including assets in the US where some sectors could benefit directly from the tariffs e.g. steel manufacturers. They should consider equity put options to reduce portfolio volatility. Put options are financial instruments that give traders an option to sell assets at an agreed price on a particular date, thus allowing traders to hedge their portfolios.

Source: AmInvest Research - 26 Mar 2018