For the last couple of months, one of the most persistent and nagging concerns that the market hasn’t been able to shake is the looming threat of a trade war. Over the last week, the timbre of that conversation shifted, moving from threat to actual reality as the Trump administration allowed exemptions on Canada, Mexico and European Union expire, imposing import duties of 25% on steel and 10% on aluminum from those regions. All three targeted governments have promised to apply retaliatory measures, which could conceivably include tit-for-tat tariffs on American exports.
Still looming is whether or not tariffs on China, aimed at reducing a trade deficit of $375.2 billion, will follow suit. The administration is due to publish a list of affected Chinese products on June 15th, with a second deadline on June 30th outlining restrictions on Chinese investment in the United States to follow.
Focusing strictly on the first round of tariffs on steel aluminum, at first blush it is only reasonable to infer that a trade war on these kinds of basic materials should have a ripple effect on multiple industries. While America produces many of the goods it needs for finished products like cars, airplanes and so on, the truth is that it also relies heavily on imported materials. A trade war should inflate the cost of those basic materials. There are already some signs that is happening, although initial indications also show those increases are negligible enough that they are simply being passed on to the consumer level without showing a material change in demand.
Increased costs for basic materials like steel aluminum should generally be a negative for industrial stocks, but the ironic thing is that many of these companies, like US Steel (X) and Nucor Corp (NUE), among others have have continued to support the imposition of duties. I think that points to a small segment of industrial stocks that stand to benefit, even if tariffs persist through a longer time period than anybody expects.
Where do the opportunities lie? The fact is that if you’re paying attention to a multinational company like Caterpillar (CAT), Intel (INTC), or Boeing (BA), you’re going to be more exposed to the negative effects of a trade war, since these companies sell big all over the world, and count the European Union and China among their biggest markets. Along with INTC, other tech companies like Micron (MU), Texas Instruments (TXN) and Qualcomm (QCOM) not only sell to Chinese companies, but also have manufacturing plants in that part of the world. So those are stocks that you would probably want to shy away from.
Previously, I’ve noted that a trade war would benefit steel and aluminum producers, and I still think that most of the benefit would be seen in those kinds of stocks. There is another segment of the Industrial sector, Machinery, that I think stand to benefit by association with the industries the tariffs are intended to protect. And while many of the companies in this industry, like Fortive Corp (FTV), Dover Corporation (DOV), and Parker Hannifin (PH), to name just a few are truly multinational companies with operations throughout the world, including Asia and Europe, most of these companies are still forecasting healthy growth in their international businesses for the foreseeable future, even with the lingering cloud of tariffs. To my way of thinking, that suggests one of two things:
The odds that tariffs will linger as is, and result in a full-blown trade war for an extended period of time, are low, or
The net real affect of the imposed tariffs will be far less significant than many believe.
The early returns at this stage, as I’ve already mentioned, are showing a fairly negligible effect on costs, and even what impact they are having doesn’t seem to be sufficient to deter consumers. It should absolutely be noted that we are still very early in a process that could take some time to either be truly felt, or to be truly understood, much less truly resolved. For the time being, though I’m willing to concede a point I heard one level-headed analyst make the other day. The U.S. economy, and for that matter the extended world economy, is quite resilient. Businesses already known for effective management have always found ways to adjust their operational models to account for changes in the marketplace and the economy, no matter whether those changes are large or small. It isn’t unreasonable to suggest they’ll do so again.