Comparing Tariff Levels. Where Does China Stand?
How do tariffs compare among the various major trading countries? Recently the CATO institute published a commentary that provided such comparisons (figure 3.)
Comparative Country Tariff Levelsource: Cato At Liberty—Simon Lester
Source: Cato Institute-Simon Lester
Analyzing the impact of the tariff structure can prove to be difficult as many countries negotiate bi-lateral agreements to moderate or eliminate some of these tariffs. Clearly, China shows up in the table with higher tariff levels. Along with that, China’s intellectual property “abuse”, and foreign business operating constraints shows the administration’s argument for change contains a degree of merit.
Industries Impacted by a Potential Trade War
The most global of U.S. industries include tech, energy, industrials, and materials. For U.S. global companies, approximately one-third of their sales comes from non-U.S. operations. In comparison, only 21% of revenues generated by Russell 2000 index companies comes from outside the U.S. that difference, in part, may explain the recent out-performance of that index, when compared to the S&P 500 index (see figure 4.)
Source: The Daily Shot
Implementing higher tariffs would likely change global trade flows. If this occurs, transportation and shipping industries will certainly feel that shift. Higher tariffs will also affect the flow of semi-finished products as they move from country to country in the complex global manufacturing systems.
Those companies providing out-sourced manufacturing for U.S. companies could suffer if potential higher tariffs impact the countries where they operate. Their flexibility to shift production will determine the level of that hurt. Overall, these uncertainties will likely contribute to businesses holding off on some capital and business expansion plans.
Trade War Impact on U.S. Consumer Companies
Up to now, the U.S. administration did not increase tariffs on consumer products with the exception of a 17% tariff on washing machines. That could change and result in a meaningful impact on many consumer product manufacturers and retailers. Figure 5 shows the relative size of consumer product imports from China.
More specifically, the U.S. imported nearly $71 billion of cellphones last year from China—our largest consumer product import. At the same time, last year, rising high end cellphone prices put a damper on demand. The proposed 10% tariff on cellphone imports would likely create further demand uncertainty for high end cellphones.
Relating National Security Issues and German Auto Tariffs
As in the case of China, there may also be an underlying issue festering below the increased auto tariff headlines with Germany. In our opinion, that underlying issue may be German defense spending which also reflects on its military readiness. More on that shortly.
In 2014, NATO members pledged to spend 2% of GDP on defense by 2024. The following table shows only Estonia, the U.K., and, yes, Greece hit that target last year (see figure 6.)
The U.S. expresses particular criticism of Germany’s relatively small proportional contribution considering the size of its economy. In addition, according to a NATO expert at the Atlantic Council in Washington, “the readiness of the German military is abysmal.” A recent article from stripes.com supports that quote. This article points out that none of Germany’s submarines can be considered operational, that only four of its 128 Eurofighter jets stand combat ready, and it lists other important areas of similar concern.
Therefore, when the administration cites auto tariffs on German cars as a security issue it may be broader than the initial reading may suggest. Once again, the administration seems to be using higher tariffs to achieve goals beyond what tariffs directly impact. Unfortunately, it may simply lead to trade wars without resolving the indirect issues.
Despite the trade war issues, we expect ultimately that world leaders will face up to the need to solve some of the legitimate concerns of this administration. Perhaps, weaker financial markets and stress on their economies will push through an ultimate agreement. Alternatively, with the president’s known focus on stock market performance, the evident investor displeasure with his trade fight may move him to a more conciliatory position. At the end, it takes two to tango. So far, no one showed up at this dance.
With that expectation, we remain of the opinion that the fed’s normalization policies will prove the most important force effecting financial markets this year and next. If that proves the case, our view remains that fed normalization efforts will cap stock multiples. Therefore, companies that can demonstrate above average earnings growth will benefit. If these stocks suffer from the trade whirlpool, investors should use that opportunity to initiate or add to growth stock positions.
Andrew J. Melnick, CFA
Chief Investment Strategist
First Capital Investment Partners