Artemis: What effect will tariffs have on equities?

After a period of volatility, markets are now (relatively) sanguine about the possibility of a genuine, all-out ‘trade war’. But tariffs of this scale will inevitably have an impact on the profitability of certain companies.

The economic wisdom of tariff-free or low tariff trade is of long standing. The repeal of the (British) Corn Laws in 1846 began the first era of free trade. Since then, the World Trade Organisation has brought tariffs down globally and encouraged such zones of free trade as Nafta in North America, Mercosur in South America and, dare we say it, the EU. The last time the US enacted protectionist measures was with the Smoot-Hawley Tariff Act in 1930. The consensus among economists is that the act worsened the Great Depression.

At Artemis, we do not have a ‘house view’. But the independent view of many of our fund managers is that the desire for political stability means that a prolonged ‘trade war’ will probably be averted. Says Cormac Weldon, Artemis’ head of US equities: “Our view is that president Trump’s worst instincts will be curbed by political reality. For instance, the US exports a significant amount of soybeans and corn to China and Mexico. These products are grown in states with a heavy Republican bias, making them particularly sensitive ahead of mid-term elections in November this year. We believe this is why the Chinese government has stated that it will use soybeans to counter any moves by the US. That said, in the shorter term the reality is that there are tensions over trade: technology stocks are potentially the next battleground.”

James Foster (of Strategic Bond) agrees: “A president so besotted with the performance of the US stockmarket is unlikely to allow this to continue for too long. We suspect the policy is a political move aimed to go down well with a partisan electorate before November’s elections; and a softer stance will be found eventually.” Ed Legget (UK Select) adds: ”… and the fact that US corporations and unions are starting to grumble about the negative consequences for US jobs suggests there should be a desire on all sides to reduce tensions over the summer.”

If the game-plan of president Trump is indeed to rattle a few (Chinese) cages and protect America’s intellectual property, a key risk is that it runs out of control. Says Jacob de Tusch-Lec (Global Income): “We are conscious that the Republicans’ tough talk and threats to impose further tariffs are primarily designed to shore up support ahead of mid-term elections. That said, harsh rhetoric can in itself lead to market sell-offs and to a slowdown in the economy (if companies stop investing due to uncertainty). We would not be surprised if – at some point – there is a return to rationality; and perhaps even a market driven more by fundamentals and less by the White House. In the meantime, we proceed with caution and in the expectation that things could remain bumpy over the summer.”

Selecting stocks, judiciously…

Clearly, the (potential) impact of these tariffs cannot be ignored - particularly at a company level where profitability may be affected. As ever, our managers are taking an active, but prudent, approach. Simon Edelsten (Global Select) says: “Our portfolio tends not to have exposure to global manufacturing giants, such as the automotive companies. We have, however, reviewed our investments in scientific equipment and automation companies, which may be affected by tariffs. While we await developments, the sizes of some of our positions in these areas are smaller than would otherwise be the case.”

In the US, Cormac believes there are some companies which can continue to prosper – even if there’s an escalation of tariffs. Boeing is one example: “Our view is that Boeing’s planes are necessary if China’s long-term plan that more of its citizens should be able to fly (both within and outside China) are to come to fruition. This requires significant investment in new planes over many years. Given that Boeing operates as part of a global duopoly with Airbus, and that both suppliers have full order books for a number of years, China would not be able to source replacements should it cancel the orders it has placed with Boeing. So we are happy to maintain our holding.”

For Global Income, Jacob’s response has been to take some of the cyclical risk out of the portfolio. “It seems prudent to be less exposed to the most economically sensitive areas than we were at the start of the year. We have, for instance, reduced our exposure to financials, particularly in Europe, where the ECB seems increasingly dovish. If global growth is cooling, the opportunity for the ECB to tighten is probably dwindling. We have also lowered the portfolio’s exposure to banks in the US (from a peak of around 12% to around 8% today) and recycled some of the capital into oil stocks. Given the magnitude of the recent sell-off in banks – and the supportive findings of the latest ‘stress tests’ – we may look to add to this area again.”

Whatever the next announcement – or tweet – may be, our managers continue to keep a watchful eye. One thing volatility does provide is a fertile hunting ground for the active investor...