By Carmel Corbett Wellso
Director of Research Carmel Wellso explains what the latest front in global trade wars means for investors.
The bull in the china shop is back at it. On Thursday, President Trump tweeted that he will impose a 5% tariff on all goods imported from Mexico until the flow of illegal immigrants into the U.S. ends. The tariffs are set to take effect June 10, and escalate by 5% every month up to a maximum of 25%.
As rattling as the news is, we do not believe broad support exists in Washington, D.C., for the president's tariff threat. For one, the potential for a policy misstep is material. Mexico is one of the U.S.'s largest trading partners, with Mexico exporting $346.5 billion in goods across the border in 2018, according to the Office of the United States Trade Representative.1 A 5% tariff would amount to a tax increase of more than $17 billion for U.S. consumers and businesses. In addition, there is little evidence that Mexico has the resources to stem the tide of migrants crossing into the U.S., tariffs or not.
The tariffs could also have a deleterious impact on the broad economy, including weighing on consumer and business confidence, already under pressure as a result of the escalating U.S.-China trade spat. In addition, Mexico could retaliate and impose tariffs on U.S. exports ($265.0 billion in 2018). The combination would likely crimp U.S. economic growth, which previously was forecast to decline to 2.2% (adjusted for inflation) during the second quarter, down from 3.2% during the first three months of the year.2 A trade war with Mexico could bring those estimates down further.
What This Means for Investors
Markets reacted negatively to the news, with stocks and bond yields around the globe falling on Friday. In addition, market projections for a Federal Reserve rate cut by year-end jumped to 93%, up from 88% on Thursday.3
Such volatility is likely to continue so long as this new front in global trade wars remains open. In this environment, we'd expect U.S. companies that earn the majority of their revenues domestically to excel, especially those firms that benefit from lower interest rates (including real estate investment trusts (REITs) and companies that rely on debt to grow).
On the flipside, the auto industry could fare the worst. Roughly 20% of U.S. auto manufacturing occurs in Mexico and 15% of U.S. auto sales come from south of the border.4 Manufacturers will have to either take the tariffs out of profits or raise prices - a move that could result in demand destruction if prices jump by 25% in some four months.
The auto supply chain would also be negatively impacted, and today that chain includes technology firms such as semiconductors and makers of sensors and electronic connectors. The good news on that end: At most, autos make up only as much as 15% of revenues for these businesses, which should help limit the hit to profits.
Another potential positive: Tariffs typically result in the local currency weakening, and true to form the Mexican peso declined following Trump's tweet. This weakening can help reduce the hit to U.S. consumers' wallets and businesses' bottom lines. However, for companies whose inputs are priced in other currencies (for example, oil refiners and consumer electronics firms that assemble PCs, servers, smartphones and TVs in Mexico) a weaker peso will not help offset the margin squeeze.
Finally, emerging markets as a whole could suffer. Exports to the U.S. make up almost 30% of Mexico's gross domestic product (GDP).5 Consequently, a 5% tariff could amount to as much as 1.5% of Mexico's economy even before considering second-derivative impacts. As Mexico is an emerging market, the country's slowdown, on top of uncertainty about China's growth, could cause the broader asset class to decline.
In short, tariffs on Mexico could create an unwelcome domino effect in the global economy - one that we believe most members of Washington would want to avoid (including President Trump, up for re-election in 2020). Still, we'd caution investors to stay alert to trade developments and be ready for potential bumps ahead.
4Janus Henderson Investors
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