The equity landscape with trade war on the horizon

Our recommendation is to be underweight (short) countries with trade surpluses against the US, the largest such countries being China, Canada, Mexico, Germany, Japan, and South Korea.

In addition, the semiconductor and car industries are particular vulnerable to further escalation, so investors should stay underweight those industries. The industries and sectors that seem to be doing the best relatively are software, health care, consumer staples, utilities, and telecom.

The table below shows our equity model’s top-ranked software companies.

Chinese equities are down 23.5% from their peak in January and down 10% during the period from when the trade war escalated to the recent alarming level. While the Chinese government is signalling its willingness to fight back, the real facts are that China is losing much more from this fight than the US, at least in the short-term.

With the Chinese economy already weakening ahead of the US tariff announcements due to slowing credit growth and lower investment levels, the US government has initiated this trade war at the worst possible time for China. On 19 June, the People's Bank of China communicated that banks’ reserve requirement ratios should be cut, increasing the likelihood of monetary easing coming soon.

Making the situation worse for China is the fact that its currency is falling against those of its its trading partners, most notably USD, as the relative wealth of Chinese consumers declines. Typically the equity market reaction to a falling currency is positive, but this time we see pressure coming from both the equity market and the currency, which is a classic sign of growing stress in the economy and financial system.