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What a trade war could mean for your portfolio

12 March 2018

FE Trustnet examines the potential implications of a trade war between the US and the rest of the world.

By Jonathan Jones,

Senior reporter, FE Trustnet

US growth expectations will be downgraded, inflation will rise and the Federal Reserve (Fed) will raise interest rates more quickly if Donald Trump does not step back from a potential trade war, according to market commentators.

Earlier this month, the US president announced that there is to be a 25 per cent global tariff placed on imported steel and a further 10 per cent tariff on aluminium.

This came as a surprise to markets, raising the fear of a trade war between the US and the rest of the world – particularly China – if other nations decided to respond in a tit-for-tat fashion.

The release of January’s US trade report last week could not have been timelier for president Trump as it showed that the US’s trade deficit was at its widest level since 2008.

 

Source: Bureau of Economic Analysis

Graham Bishop, investment director at Heartwood Investment Management, said: “For Donald Trump the politician, who was elected on the mantra of putting ‘America First’, there is little escape from the fact that the US economy remains the world’s largest consumer of goods and services.

“Economic logic, though, tells us that trade wars would ultimately make American goods less competitive, resulting in higher inflation and higher interest rates, in turn hurting the US consumer.”

However, he said that if the president were trying to start a trade war with China then steel tariffs would not be the first line of attack as the country only exports 0.2 per cent of its steel production to the US.

More likely is that he is doing so for two reasons – one to help with the renegotiation of the North American Free Trade Agreement (NAFTA), as Canada is the largest steel exporter to the US, and two to improve relations with his core voters before mid-term elections kick off.

“Satisfying domestic political considerations is a high stakes game. The Trump Administration’s war of words risks opening the US economy to retaliatory efforts,” Bishop said.

“We are not there yet, but there is a danger that the announcement of tariffs could lead to a negative turn in US and global policy setting. Markets will not react favourably if he responds too heavily to populist impulses.”

Robert Lea, head of global equity research at Ashburton Investments, showed more concern, stating that he expects the recent import tariffs to have a negative impact on US economic growth.

“The rise in prices will also act to stoke inflationary forces in the economy, making it more likely that the Fed would raise rates more quickly than the market currently anticipates.”


This is without the threat of retaliation from countries and means that unless the president decides to reverse the current course of action the US economy could come under pressure.

While it is not likely that it necessarily changes the outlook for the economy as a whole, however, Lea said this could weigh heavily on market sentiment.

As such, he remains cautious on global equity markets having moved to a neutral weighting in January.

“The recent pull-back in equity markets is not unexpected and is something about which we previously cautioned,” he said.

“High equity valuations, bullish investor sentiment and extreme positioning are not the necessary ingredients for further gains, especially coming off the back of the very strong performance seen in 2017. We expect volatility to remain elevated in the near term.”

Lea said the market has continually underestimated the scope for a rise in inflation this year – both in the US and globally – and has potentially misjudged the Fed’s desire to normalise interest rate policy at a quicker pace than many expect.

“That said, rates should likely remain low, in absolute and historical terms. We still expect the Fed, along with other central banks, to raise rates at a measured pace,” he noted.

Overall, sectors that normally fare better in an improving growth and rising rate environment include financial stocks, consumer discretionary as well as energy and commodity names.

Meanwhile, consumer staples, utilities and other so-called ‘bond-proxy’ stocks are at risk of underperforming when rates rise.

Architas investment director Adrian Lowcock said there are a number of funds however that could help to insulate an investor’s portfolio from a potential trade war.

“Trade wars are not easy and they are not predictable. If things escalate then what started out as a targeted policy on steel and aluminium could easily spill over to other areas,” he said.

“Given that it is impossible to predict which markets will be affected and by how much investors are wise to stick to good and trusted managers and ensure they are diversified.”

One option is the five FE Crown-rated Lindsell Train UK Equity fund, run by FE Alpha Manager Nick Train, which has been a top performer over one, three, five and 10-year timeframes.

Performance of fund vs sector and benchmark since launch

 

Source: FE Analytics

Train’s approach means that the fund is well positioned to weather the headwinds of a trade war, Lowcock said.


“The fund is run with a long-term focus on their investment performance. Nick Train looks for companies with excellent brands, franchises and unique market positions,” he explained.

“He favours those which are conservatively financed and are able to produce a high and stable return on capital.  These sort of companies help themselves and would be well positioned to pass on the impact of any future tariffs.”

The £4.7bn fund has a yield of 1.91 per cent and a clean ongoing charges figure (OCF) of 0.72 per cent.

Another is the £607m Kames Property Income fund, run by David Wise and Richard Peacock, which has returned 29.44 per cent since its launch in 2014, as the below chart shows.

“Property should help protect investors from any of the inflationary effects of a trade war as well as provide diversification away from equities,” Lowcock said.

Performance of fund vs sector since launch

 

Source: FE Analytics

The fund aims to deliver income by investing directly into properties, although the manager will use real estate investment trusts (REITs) for strategic asset allocation and liquidity. This allowed the fund to stay open during the post Brexit crisis in the sector.

“The fund is operating in a reasonably niche segment of the property market, looking for opportunistic value add opportunities in smaller properties which should give it more flexibility,” Lowcock noted.

Kames Property Income has a yield of 5.2 per cent and an OCF of 0.87 per cent.

Finally, Lowcock said the four crow-rated JPM Global Macro Opportunities fund may also be another to look to if a trade war begins to take shape.

He said: “The team believe that global macro trends are the main drivers of returns for asset classes and they look to identify and exploit these with the aim of delivering positive returns in all conditions and a priority on capital preservation.”

Run by James Elliot and FE Alpha Manager Shrenick Shah, the £1.1bn fund has a yield of 0.86 per cent and an OCF of 0.75 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.