Family office/ultra-high net wealth adviser Pictet, has delivered a potential storm warning to its clients, due to the threat posed by an escalating trade war between the US and China.
Luca Paolini, Pictet Asset Management chief strategist, and Patrick Zweifel, chief economist, say: “The effects of a full-scale trade war will extend far beyond the US and China, threatening stagflation worldwide.”
Wall Street would suffer more from an escalation in the trade war than other stock markets. This is because the US is the most expensive market in our valuation model
Pictet has crunched data which shows a trade war could hit far and wide. It says the escalation of a trade war would hit open economies like Singapore and Taiwan, looking at the value of supply chains as a percentage of exports.
Hungary, the Czech Republic and Ireland are significant European suppliers and would also be hit hard. The US and China are relatively closed economies, suffering less in a relative sense, but more in a monetary sense. Argentina, blessed by a remote location and closed economy, is best protected, along with New Zealand.
The US Republican administration doubled tariffs on $200 billion of Chinese goods earlier this month. China retaliated by raising tariffs on $60 billion worth of imports from the US. The US is preventing the use of technology from Chinese telecom giant Huawei Technologies in 5G mobile networks globally, citing security risks. The Trump administration added Huawei to a trade blacklist on Thursday.
On Thursday, China’s foreign ministry spokesperson said the US needs to be “more sincere” for trade negotiations to be successful, according to the state-run news agency. This implies a significant lack of trust.
Pictet says a 10% tariff on US trade, if passed on to the consumer, would lead to a 0.7% increase in global inflation. This looks small, but it has a big impact in monetary terms. It could reduce corporate earnings by 2.5% and reduce earnings multiples across the world by up to 15%.
This could hammer global equities by between 15% and 20%, turning the stock market clock back three years, according to Pictet.
“Wall Street would suffer more from an escalation in the trade war than other stock markets,” says Pictet. “This is because the US is the most expensive market in our valuation model. On a 2019 price to earnings basis, it trades 30% higher than European, Japanese and emerging market counterparts.” Bonds will rise at the outset, but fall back as inflation rises higher.
Some think the costs of a trade war are so high that a Sino-US deal will surely be struck at some point. But a narrative is developing that it won’t. This has left some analysts talking about the possibility of a debt crisis, or worse, as countries and companies weakened by a trade war find it harder to meet their debt obligations.
Pictet’s Paolini says: “I would not call it a debt crisis per se but rather a global recession that will inevitably put pressure on highly indebted companies as their cost of capital rises and revenues collapse.”
He adds: “As experience unequivocally shows, no one wins a trade war.”
Ray Dalio, founder of asset manager Bridgewater Associates, says the US and China may or may not be able to negotiate a trade deal. To him, however, the big issue relates to the way two very different super-powers can co-exist in the world.
In a post on Linkedin, he said: “Fundamental issues – such as how companies relate to governments – are at the heart of the “trade” dispute and where the stumbling blocks lie and will remain.
“Regarding where that competition will lead, I can envision either a) good outcomes if these two countries’ leaders treat this competition like other great competitions that make both sides stronger and if both sides realize that win-win competitions are much better than lose-lose wars, or b) terrible outcomes if these two countries’ leaders fight to make the others make existential changes that they will fight against.
“Once again, as with our domestic conflicts, the biggest question is how the people who have their hands on the levers of power will be with each other. That will significantly influence just about everything in our lives.”
And, right now, things aren’t looking great.