Image Source: Michael Vadon

We think investors shouldn’t overreact, but we didn’t have two world wars in the last century because leaders of superpowers “got along” nicely.

By Brian Nelson, CFA

News that President Trump is asking to identify $200 billion worth of Chinese goods on which to levy a 10% tariff has the markets a bit jittery. China’s Ministry of Commerce responded that if the US moves forward with the tariffs, it would take “comprehensive quantitative and qualitative measures and retaliate forcefully.”

We expect news regarding trade tensions between the US (SPY, DIA) and China (FXI, MCHI) to only intensify in the coming weeks, as the White House seeks to pursue what is likely game theory to achieve better trade agreements. We would expect any fallout from what appears to be posturing to be transitory, however, and we believe most technology (XLK) entities remain quite resilient given their net-cash-rich balance sheets and tremendous free cash flow generation. Facebook (FB), Microsoft (MSFT) and Apple (AAPL) remain a few of our favorites.

Consumer staples (XLP) entities likely have bigger worries than trade spats, too, as private label competition and rising promotional expenses may do more to damage their gross margins than tariff-driven higher packaging and materials costs. Packaged foods companies such as Campbell Soup (CPB) and other consumer staples entities such as Procter & Gamble (PG) will have their work cut out for them to grow gross margins, regardless of what happens to global trade. Consumers may be becoming more and more unwilling to pay up for branded goods as they have been absorbing price increase after price increase for years already.

Furthermore, tensions that may stymie business confidence are never a good thing, and if businesses, in general, decide to step back from spending and hiring in the midst of trade uncertainty, trade posturing, by itself, from both the US and China could translate into tangible negative business impacts across the globe. We think the big industrial entities may be feeling the brunt of global trade concerns. Boeing (BA), Caterpillar (CAT) and Deere (DE) may only be hurt the most, if only on the margin, from protectionist policies, especially during downturns. We’re less concerned about Boeing’s fundamentals given its backlog of unfulfilled deliveries than we are with Caterpillar and Deere, however.

As we outlined in our March 22 note, Trump Targets China with Tariffs, “there is a long line of history that suggests leaders can and do overreact to real or implied threats (economic or otherwise), particularly when ‘ego’ is involved. We didn’t have two world wars during the 20th century because leaders of superpowers “got along” nicely. Bad things, sometimes, can and do happen, but in some respects, it’s actually a good thing that we’re talking about a trade war and not an actual military conflict.” We don’t think investors should overreact to “trade war” fears, but this nine-year bull market is getting long in the tooth, and the list of the number of positive catalysts to plow earnings growth ahead continues to shrink.

Rising interest rates and the threat of a reversion in corporate tax policy to prior levels during subsequent administrations in the event of the next recession that shrinks tax proceeds remain our biggest intermediate-term worries. Rising interest rates directly impact the intrinsic value of equities as borrowing cost rise (there is also a trade-off to fixed-income instruments as rates rise), and the possibility of the US having to raise corporate tax rates during the next downturn to shore up finances may only exacerbate the natural conditions of an otherwise “normal” recession. US debt stands north of $21+ trillion, and the Fed is only inching higher with borrowing rates after a prolonged period of zero-interest-rate policy.

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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.