Should We Fear The Trade War?

This Article was first published on 29th June 2018 on our Asia-In-Focus Newsletter. To get the latest newsletters, click here.

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Asia In Focus

Should We Fear The Trade War?

We are exactly at the halfway mark of 2018, the stock markets around Asia are not enjoying a good year till now. It seems that most of the major Asian exchanges are seeing a loss-making year. The Shanghai Composite Index has declined 15% this year. The Hang Seng Index, Singapore Straits Times Index and the Malaysia Kuala Lumpur Composite Index have all declined 5.1%, 4.7% and 5.1% respectively.

And the market seems to feel the main reason for all these declines is:

The US-China Trade War

Well, even though no one dares to use the term “trade war” to describe what is happening with the USA and China, I believe everyone is thinking about it. Call it what you might, the tit-for-tat trade tariffs announcement between the two giants are causing fear in the market.

So What Is Happening Now?

31^st October 2017: The US International Trade Commission started an investigation and found that the imports of solar panels and washing machines have hurt their local manufacturers.

22^nd January 2018: President Trump approved tariffs on all solar panels and washing machines imports.

9^th March 2018: the US added a global tax on steel and aluminium imports.

2^nd April 2018: China added tariffs on US products like nuts, wine, pork, fruits and others.

3^rd April 2018: the US responded by imposing 25% tax on about 1,300 Chinese products ranging from medical, machinery to even aerospace.

4^th April 2018: China also added 25% tax on USD50 billion worth of US Products.

22^nd April 2018: Two nations indicated that they are interested to hold talks to discuss the trade situations.

May 2018: Trade talks ended with no real solution.

June 2018: US announced more tariffs on USD34 billion of Chinese products, promising more to come. China promised to retaliate and President Trump threatens to extend the tariffs to more than USD400 billion worth of imported products.
And so, here we are.

It is all seem a little childish to you, well that’s because it is.
Basically, two kids who are unable to learn to share decide to punish the other party for it. And each is looking at us, saying “Well, HE STARTED IT.”

The Strategy of An Eye For An Eye

Interestingly, this childish behaviour of tit-for-tat is actually the right researched-based response to a trade war. What the two countries are experiencing is an example of Game Theory. You can find thousands of videos on Youtube explaining what is Game Theory so I will not go into that here. But a great podcast I just listened to on why using the strategy of an eye-for-an-eye is the best option for both China and US now, until one party need to throw the other a bone. It is a fascinating listen, you can listen to it here.

The Little Guys Always Get The Short End Of The Stick

However, when giants clash, everyone else suffers. For one, consumers on each side of the Pacific will need to be prepared to pay higher prices. My expectation is that many of the large companies affected might not be that badly affected. This is because it all comes down to who has the bargaining power.

If a major company such as Apple Inc is affected by the new tariffs because many of its products are produced in China, they could have the power to go to their suppliers to ask them to reduce their prices so that Apple can keep its margins. By partially passing the cost to its customers and asking its suppliers to take up the cost, Apple might not even be affected at all.

On the other hand, its suppliers such as Foxconn would need to think of ways to navigate around that; such as starting the largest manufacturing plant in the US (look at the news today). Or turn around and forcing its suppliers to take up the cost. Given that they are one of the largest electronic assemblers and manufactures, most likely they might also be able to pressure their suppliers to reduce their margins so that Foxconn can keep theirs.

So many of the smaller suppliers, the ones located and operate in Singapore, Malaysia and other smaller suppliers might be the one taking the heat.

The Big Guys Might Win

While the small guys, the consumers and the smaller suppliers, suffer, the big guys might actually win. For one, the US government might end up increasing its revenue through more tariffs and duties, all the more helping it strengthen its balance sheet. On top of that, by creating this trade war which might force consumers to pay more for products, the US government might finally be able to create something they have been hoping for the US economy for so many years; inflation!

China could also use this as an excuse to more aggressively push forward their plan of boosting internal consumption within China, something the government has been pushing to reduce their reliance on the US.

What Does History Tell Us?

For one, history told us that trade war can last a long time. In fact, many of the past trade wars need at least 3-5 years before they are reversed. That is when the tariffs act was repealed when the political will disappears. Some might just continue for decades and become the new normal.

So, don’t be surprised if we will be watching this movie for a few more years. We are only in Act 1.

Why Does It Not Matter To Investors?

Yet, as damaging and HUGE (say it like Donald) as the trade war might be. As an investor, I am really not that worried by it. For one, the world has always been an unexpected place. But the ones that thrive in the world of business are the ones who are most flexible and creative in changing with the times.

So, when we invest, we are not just investing in a stock or a company. We are investing in the people who run these businesses. We are investing in management who are smart enough to find solutions in going around the issue and solving it. We see the CEO of Foxconn investing heavily in the US to have a manufacturing arm right in the US, that is a clear example of how to adapt with changing times. Apple is their largest customer, the US is Apple largest market, Apple will never abandon this market, Foxconn will always do its best to ensure Apple stays a customer.

If we are investing in companies, shouldn’t we be choosing good management who we trust will be able to navigate through these rough seas? And if we do not trust the management to be smart enough or the business to be strong enough to brace through the storm, why are we even investing in them in the first place.

My first principle of investing is always: My capital is my limiting factor in investing, not the lack of opportunities to invest in. Choose Wisely.

Till we meet again,
Stanley
Editor

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