In six weeks, the trade war ceasefire will end…
And the war will most likely continue.
Not everyone is a loser in this war, though. And I’ll tell you one sector that could be a winner.
The state of war
The U.S. and China have been locked in a trade war since March 2018.
That’s when U.S. President Donald Trump slapped tariffs on Chinese aerospace, communication and machinery products.
Since then, both sides have exchanged in tit-for-tat retaliation of tariffs.
So far, US$250 billion worth of Chinese goods and US$110 billion worth of U.S. goods are subject to tariffs ranging from 10 percent to 25 percent.
And unless a compromise is reached, the rest of Chinese imports entering the U.S. (with an estimated value of US$230 billion) will likely also be hit with an initial 10 percent tariff at the end of February.
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Of the original US$250 billion in tariffed Chinese goods, US$200 billion will also see tariffs rise from 10 percent to 25 percent.
China only imports around US$120 billion-US$130 billion in goods from the U.S. each year. So it can’t match impending U.S. tariffs – China just doesn’t buy enough stuff from the U.S.
But Beijing has vowed to retaliate in other ways. One way is to devalue its currency, the yuan, which will make Chinese products cheaper to export and blunt the impact of tariffs.
Second is to prevent Chinese tourists from traveling to the U.S. This may sound trivial at first, but over three million Chinese travel to the U.S. each year. And they spend an estimated US$20 billion when they travel.
In this way, restricting Chinese travel to the U.S. is the equivalent of reducing imports from the U.S. – by depriving it of tourism revenue.
Things don’t look encouraging for a trade war deal
The U.S. trade deficit with China hit a record US$323.3 billion in 2018, up 17 percent from the previous year.
A trade deficit is when a nation imports more from another country than it exports to that same country. And the U.S. trade deficit with China is now larger than the GDP of Pakistan.
So recent tariffs haven’t had any effect (yet) on reducing the deficit. Some of this growth in the deficit is probably due to front-loading. That’s when a company orders a larger-than-normal number of goods in advance, in anticipation of needing to pay more after a looming tariff hike. It’s like stocking up before a price hike.
A rising trade deficit gives President Trump more reason to demand major trade concessions from China.
These include putting an end to forced technology transfers for U.S. companies operating in China, scaling back retaliatory tariffs, and increasing imports of U.S.-made products.
This is creating tremendous uncertainty. So the trade war has been negative for global markets. Asia has been hit the hardest.
But what happens if a deal is reached?
Recent history suggests that won’t happen. But it could.
And one industry would be the likely big winner.
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Goods made to produce other goods
The capital goods industry (also known as the industrial industry, as it is comprised of industrial goods manufacturers) has been the biggest loser in the trade war.
Capital goods are man-made durable items that factories and other businesses use to produce other goods, as well as services.
They’re the bright-orange, molten-hot smelters used by steel plants to smelt iron out of the ore. They’re gigantic robotic arms that lift car doors and body frames in a Ford Explorer production line.
Spending on these capital goods form the basis for growth in economies, as it signals expansion in businesses.
Companies also have their own investment cycles that take into account the growth in their respective markets, regardless of economic growth.
But the trade war has resulted in many of the world’s companies putting off their expansion plans.
Apple (Exchange: New York; ticker: AAPL), for instance, will produce and sell fewer iPhones if 25 percent tariffs hit their already expensive line of smartphones.
Boeing (Exchange: New York; ticker: BA) will likely build fewer planes if current tariffs on engine and fuselage parts increase costs to customers.
Siemens (Exchange: New York; ticker: SIEGY) and Fanuc (Exchange: New York; ticker: FANUY), two of the world’s leading factory automation equipment suppliers, will produce fewer robots if those factories might need to relocate because of tariffs.
In short, the trade war makes it difficult for businesses to spend for growth.
This is why, in 2018, the MSCI World Capital Goods Index fell 16.5 percent.
That compares with a 5.5 percent loss for the MSCI World Consumer Discretionary Index, a tiny 0.9 percent fall in the MSCI World Utilities Index and a 3.0 percent gain in the MSCI World Healthcare Index.
As you can see form the chart above, the MSCI World Capital Goods Index has performed almost as poorly as the MSCI Asia ex Japan Index since the start of the trade war.
And while it has recovered since the start of the year, it’s still down 11.5 percent since March 22, 2018. That compares with a 3.2 percent loss for the MSCI World Index and an 0.5 percent gain in the S&P 500 Index.
Capital goods do well in a recovery
As I just showed, the capital goods industry was one of the worst sectors to invest in last year.
But over the last 15 years, this is an industry that has outperformed most markets during periods of expansion and recovery (see chart below).
If Chinese President Xi Jinping and Trump come to a lasting agreement on trade, that would be great for the global stock markets in general.
And an end to the trade war – or even a reduction in tariffs for some products – will likely have a positive impact on demand for capital goods… and make this industry one of the best performing of 2019.
One way for investors to get exposure to a recovery in global demand for capital goods is through the iShares S&P Global Industrials ETF (Exchange: New York; ticker: EXI).
Managed by BlackRock, EXI seeks to track the investment results of an index composed of global equities in the industrials sector, with heavy weighting towards the U.S. (51.9 percent) and Japan (16.7 percent).
If the trade war ends, this is one ETF you’re going to be pleased to have in your portfolio.
Editor, Stansberry Pacific Research