Friendly Fire

U.S. companies have more earnings exposed to U.S. import tariffs than China’s.

Today’s CIO Weekly Perspectives comes from guest contributor Bin Yu, Senior Portfolio Manager and Head of China Equities.

In Europe and North America, the airwaves buzz with anticipation of an all-out trade war between the U.S. and China. President Donald Trump has publicly threatened to impose tariffs on the entire $500 billion worth of goods that flow from China to the U.S. each year, and last week he proposed increasing tariffs on an existing target list of $200 billion of Chinese imports.

The feeling here in Beijing is quite different. In China, there is not a great deal of concern about tariffs. There is even an emerging debate within both the government and the business community about whether retaliation against further U.S. import tariffs would be worthwhile.

Most accept that both sides would lose in an all-out trade war, as the textbooks suggest. Many here also recognize that China and the U.S. will hurt their own companies and consumers, rather than the other party’s, with their tariffs—and that U.S. consumers and U.S. companies will feel most of the pain.

Corporate China Does Not Export Much to the U.S.

That might seem counterintuitive. The U.S. exports only $130 billion of goods to China each year. Surely, as some of the more aggressive advisors to the White House have argued, that means China has much more to lose in a tariff war?

This argument fails because it is inadequate to describe the economic relationship between two countries using only the trade balance. That number tells you very little about where revenues and earnings are being booked—especially when the two countries are China and the U.S.

How many Chinese brands can a typical American consumer name? Not many, and for good reason. The $500 billion of goods shipped from China to the U.S. is not 10 million Huawei mobile phones. While a handful of Chinese companies such as domestic appliance manufacturers get 10-15% of their earnings from American consumers, most analysts estimate that the listed China equity market as a whole generates barely 5% of its revenue in the U.S. The companies that China equity investors focus on—think Alibaba or Tencent, for example, or Chinese banks—often have no direct exposure at all.

The fact is that most of those $500 billion of imports are goods made by U.S. companies in China, for U.S. consumers. Apple alone imports some $50 billion a year in hardware from China. A large proportion of the rest is electronic components and machine parts made by Taiwanese, Korean or European companies for American businesses.

In short, when we consider earnings rather than the trade balance, it appears that corporate China needs the U.S. much less than corporate U.S. needs China.

The Chinese Consumer May Turn Against U.S. Brands

Moreover, anyone living, working and shopping in China knows that tariffs are not the only threat to U.S. firms. These businesses have spent a lot of time and money building strong brands for the Chinese consumer market, and those strategic interests are at risk, in part from government intervention but mostly from customer sentiment. Again, think of Apple generating more than a quarter of its earnings, or $18 billion a year, in China.

China’s consumers have voted with their High Street dollars during past international disputes, without explicit official encouragement. In 2012, when China and Japan argued over the sovereignty of islands in the East China Sea, sales in China of Japanese autos, most of which are made in China, plunged by some 50%. Korean automakers suffered similar declines last year, during a dispute over anti-missile defense installations. Consumer staples products, such as household goods and cosmetics from Japan and Korea, saw a smaller but still significant impact on sales, and leisure travel to Japan and Korea also fell. These headline-driven sales declines lasted two to four quarters, on average, before stabilizing.

That history suggests that Chinese buyers opting for a Volkswagen over a Buick, Chevrolet or Focus represent a substantial risk for the likes of General Motors and Ford. Businesses such as Nike or Starbucks, which get 24% and 15% of their earnings from China, respectively, might also have their momentum disrupted.

What Are the Risks for China?

From China’s point of view, while some U.S. products are easily replaceable (such as agricultural commodities), most of its $130 billion of imports from the U.S. are competitive, high-quality products that are difficult to replace (such as aircraft parts and semiconductor chips). The government recognizes that imposing tariffs on those will have no effect other than to hurt Chinese businesses and consumers. Along with the lack of direct harm to corporate China coming from the U.S. import tariffs, this is what feeds the domestic debate about the efficacy of retaliation.

Politics can overwhelm economic self-interest, of course. While U.S. companies are more directly exposed to tariffs than China’s, a 10% tax on every dollar of U.S. imports from China would have a big negative impact on the global economy and investor sentiment, which would damage China along with everyone else—and is not something we can rule out at this stage. Nonetheless, evidence from the first round of tariffs, with its already growing list of exemptions and subsidies, suggests that self-interest still prevails.

Longer-term, the emergence of China’s economy as a competitor with the U.S. is a strategic challenge that is independent of President Trump and will persist after he has left office. Corporate China will take the same commercial and pragmatic approach to that as it has to this year’s tough talk on tariffs.

In Case You Missed It

  • U.S. Personal Income and Outlays:  Personal spending increased 0.4%, income increased 0.4%, and the savings rate increased to 3.2% in July
  • Case-Shiller Home Price Index:  June home prices increased 0.7% month-over-month and increased 6.5% year-over-year (not seasonally adjusted); +0.2% month-over-month (seasonally adjusted)
  • Euro Zone 2Q 2018 GDP (first estimate):  +1.4% annualized rate
  • Euro Zone Consumer Price Index:  +2.1% in July year-over-year
  • Bank of Japan Statement on Monetary Policy:  Governor Kuroda raised the yield cap on the 10-year government bond to 0.2% from 0.1%, increasing flexibility without tightening policy
  • ISM Manufacturing Index:  -2.1 to 58.1 in July
  • U.S. Employment Report:  Nonfarm payrolls increased by 157,000, and the unemployment rate decreased to 3.9% in July
  • U.S. ISM Non-Manufacturing Index:  -3.4 to 55.7 in July

What to Watch For

  • Thursday, 8/9:
    • U.S. Producer Price Index
    • Japan 2Q 2018 GDP (first estimate)
  • Friday, 8/10:
    • U.S. Consumer Price Index

– Andrew White, Investment Strategy Group

Statistics on the Current State of the Market – as of August 3, 2018

Market Index WTD MTD YTD
Equity      
S&P 500 Index 0.8% 0.9% 7.4%
Russell 1000 Index 0.8% 0.9% 7.4%
Russell 1000 Growth Index 0.9% 1.6% 12.2%
Russell 1000 Value Index 0.8% 0.2% 2.4%
Russell 2000 Index 0.6% 0.2% 9.7%
MSCI World Index 0.0% 0.1% 4.1%
MSCI EAFE Index -1.4% -1.2% -1.1%
MSCI Emerging Markets Index -1.7% -1.2% -5.6%
STOXX Europe 600 -1.2% -1.5% -1.4%
FTSE 100 Index -0.5% -1.1% 2.1%
TOPIX -1.9% -0.6% -3.0%
CSI 300 Index -5.8% -5.7% -16.2%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index 0.1% 0.1% 0.1%
Citigroup 10-Year Treasury Index 0.1% 0.1% -3.2%
Bloomberg Barclays Municipal Bond Index -0.1% -0.1% -0.1%
Bloomberg Barclays US Aggregate Bond Index 0.1% 0.1% -1.5%
Bloomberg Barclays Global Aggregate Index -0.3% -0.3% -1.9%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.1% 0.1% 2.8%
ICE BofA Merrill Lynch U.S. High Yield Index 0.3% 0.2% 1.4%
ICE BofA Merrill Lynch Global High Yield Index 0.1% -0.1% -0.3%
JP Morgan EMBI Global Diversified Index -0.5% -0.3% -3.1%
JP Morgan GBI-EM Global Diversified Index -0.6% -0.5% -5.2%
U.S. Dollar per British Pounds -0.8% -0.8% -3.8%
U.S. Dollar per Euro -0.5% -0.9% -3.5%
U.S. Dollar per Japanese Yen -0.2% 0.7% 1.3%
Real & Alternative Assets      
Alerian MLP Index 5.3% 3.4% 9.5%
FTSE EPRA/NAREIT North America Index 3.4% 1.4% 3.7%
FTSE EPRA/NAREIT Global Index 0.7% -0.1% 0.7%
Bloomberg Commodity Index 0.1% -0.6% -2.7%
Gold (NYM $/ozt) Continuous Future 0.0% -0.8% -6.6%
Crude Oil (NYM $/bbl) Continuous Future -0.3% -0.4% 13.4%

Source: FactSet, Neuberger Berman.

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