Is protectionism going to help make America great again? Or is it just going to hinder the US’s progress moving forward and allow other economies like China and Europe to take over them? Credit Suisse (CS) weighs in on the cost and benefit of protectionism and analyses whether anyone stands to gain from protectionism.
Here are some of the winners and losers from the US’s protectionist measures:
1. US (Relative Winner)
Countries that have the largest bilateral trade surplus with the US would most probably be the relative losers of the protectionist stance. This is considering the fact that most protectionist policies are mainly targeted at reducing a country’s trade deficit.
CS opines that protectionist measures could end up giving a relative boost to the US’s Gross Domestic Product (GDP), given that the non-petroleum trade deficit currently stands at 3.65 percent of US GDP.
In addition, US is a relatively closed economy. Its trade-in-goods constitute about only 21 percent of its GDP, which is among the lowest in the G20. CS thinks that economies that are relatively closed but depend on large domestic markets, typically do better when protectionism is the main political stance.
CS thinks the EU wouldn’t be affected much by the US’s protectionist stance relative to other major regions for two reasons:
- The EU is still one of the largest free trade areas in the world. 63 percent of EU countries’ total exports are to the rest of the EU, compared with eight percent of exports to the US.
- There is still significant pent-up domestic demand from EU to keep the EU economy growing.
Furthermore, if protectionism from the US increases, Europe could get another strategic advantage from foreign direct investment (FDI) and export demand. Those FDI and export demand that used to be directed to the US may now shift to Europe, particularly from China.
3. Emerging Markets
While the possibility of Trump going ahead with his protectionist measure isn’t impossible, CS believes that worries over the impact of protectionism have been overstated.
Rising yields in developed markets and the impact of a stronger USD have also been inflated. CS opines that the US would unlikely return to pre-WTO world order. As such, CS remains overweight on global emerging markets equities.
One of the largest losers of US protectionism is China. CS thinks that, for now, China’s domestic market might not be able to withstand an export slowdown even with efforts from the Chinese Central Government to move the Chinese economy towards a consumption economy like the US.
This is because private consumption accounts for only 38 percent of GDP in China, unlike the US and EU with 69 percent and 56 percent respectively.
At the core of its economic structure, China is still a very manufacturing-intensive economy. Its manufacturing accounts for almost 30 percent of GDP. Thus, CS thinks that a goods trade war would spell trouble for China.
CS also believes that China’s investment share of GDP (at 42 percent) has resulted in “excess capacity” and with China accounting for ~25 percent of global investment. Yet, it only accounts for ~10 percent of global consumption. This excess capacity needs to be accounted for.
If the US is no longer importing because of protectionist measures, then China will have a lot of excess capacity in its economy, left with no avenue to be absorbed.
2. Global Equities
Protectionist stance is considered a bane for economies, according to CS. This is because protectionist policies will worsen the inefficiency of resources allocation, ultimately weighing on companies’ profitability and their risk appetite.
Companies might be reluctant to take on risks to invest in new services as they focus on achieving cost efficiency in the short run. That being said, protectionism will likely lead to the rise in inflation.
Historically, equities have been performing well against a backdrop of an inflation rate between one to three percent, which are becoming the norm across the developed world. The downside is that when inflation rises above three percent, equities tend to underperform and trade at lower valuations.
The combination of fiscal stimulus, protectionism, an immigration measures and an economy at full capacity all simply points to one thing: more inflation. Inflation will lead to rising nominal bond yield and thus lead to falling bond prices.
Protectionism also has two negative funds flow implications. Firstly, the PBOC and BoJ owns 15 percent of the US Treasury market in total and this gives them more motivation to liquidate these holdings.
Secondly, if President Trump intends to suppress the US Dollar’s strength, he might start by trying to influence the US Federal Reserve to liquidate its bond holdings.
This is because monetary tightening measures (via a rise in long-term interest rates) is “likely to be less dollar supportive than a rise” in short-term interest rates (from selling bond holdings). Both will lead to the same outcome: further driving the price of bonds down.
Investors Takeaway: EMs Valuation Cheap For Picking
CS believes that Emerging Market (EM) equities will be the main beneficiary of inflation, should Trump go ahead with his protectionist policies.
By measuring normalised earnings, EMs have shown much cheaper valuations against Developed Markets (DMs), with the PB of EMs at a 30 percent discount to DMs. CS wrote, “Using the Shiller methodology, i.e. valuing the market on the basis of real 10-year average earnings, the PE is just under 10x.”
CS recommends investors to diversify their portfolio with an overweight weighting of EM equities after investors take profit from the overvalued DMs.
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