Trump’s escalation of the trade dispute triggered a broad market selloff in May. But is this merited? Most companies have negligible exposure to Greater China so, why the panic? Not only should investors not worry, but they should also view this as an opportunity to buy good companies at a discount.
Following President Trump’s now famous tweets on May 5th announcing additional tariffs on Chinese goods, the U.S. stock market lost $5 trillion in stock market value through the end of May. But is this merited? Usually, when steep stock market declines occur, there is a precipitating event or series of events that drive investors to act. Typically, those events do not have an equal impact on U.S. companies even though stock market drops produce price declines across the board. Perhaps now is a good time to remind investors not to worry in the face of rising trade tensions, and even to determine if they can invest money in U.S. companies opportunistically.
Remember the Brexit Shock?
We can take a lesson from the Brexit vote in June 2016 that shocked the world and drove global markets sharply lower. Like the escalating US-China trade tensions, it was a geopolitical macro event everyone thought possible but not probable. While everyone knew it would be a market disruptor, no one really knew for certain the magnitude of its impact on the economy or the markets. As with the current trade tensions, it cast a long shadow of uncertainty over the financial markets, and we know the markets don’t like uncertainty. So, the market punished all stocks, regardless of their actual exposure to the risks of Brexit.
But, you will recall that the stock market went on to gain nearly 12% in the second half of the year. Now, three years later amid new record highs in the market, the Brexit shock appears as nothing more than a tiny blip on the chart.
Unquestionably, the US-China trade war has the potential to wreak far more havoc on the global economy than Brexit ever could. A weakening China economy is not good for the global economy. Higher commodity prices and production costs will definitely hurt American consumers in their pocketbook. There’s no question, companies’ earnings could be impacted.
But, until Trump’s announcement, the stock market thought 25% tariffs were possible, but not probable, which is why it sold off in May. Now more uncertainty looms, which will drive volatility, so buckle your seatbelts. There’s no certainty that the market will shrug off escalating trade tensions as easily as it did with Brexit.
What’s the Real Exposure?
Thanks in large part to the dominance of index funds and automated trading, the market doesn’t discriminate when it wants to hammer stocks. However, stocks with a high level of exposure to Greater China, such as IT and semiconductors, were hit especially hard. Apple (NASDAQ: AAPL) was drilled hard for its 30% exposure. Intel (NASDAQ: INTC), Qualcomm (NASDAQ: (NASDAQ: QCOM), Micron (NASDAQ: MU), Broadcom (NASDAQ: AVGO), and NVIDIA (NASDAQ: NVDA) with around 10% exposure, felt the wrath of nervous investors.
However, surprisingly, the average revenue exposure of S&P 500 companies to Greater China is just 2%. When viewed from that perspective, the exposure is negligible. And, considering that many of the more well-managed companies will be able to make the necessary adjustments to their supply chains, any top-line earnings pressure will be temporary.
What Should Investors Do Now?
The first thing investors should do is take a breath. It’s moments like this that distinguishes rational, strategy-driven investors from the charging herd. It’s important to keep the long-term perspective in view and stay focused on your investment strategy, neither of which should change dramatically with changing market conditions. More specifically, investors should:
1) review their portfolio for revenue exposure to Greater China to determine if they own companies that could be permanently damaged by a prolonged trade war,
2) rest easy knowing that the vast majority of companies have little to no revenue exposure to China,
3) look to be opportunistic and invest in companies whose stocks have sold off without sufficient reason
Second, tune out the noise. You can be certain that the media don’t share your interests when they launch into hyperbolic fits. The only thing that matters is your long-term objectives and that you have a strategy in place to achieve them.
Don’t Worry, Be Happy
Finally, have faith in the future. Since WWII an endless string of major macro events have bombarded our economy and markets, yet the stock market has a found a way to grow 200-fold. The U.S. economy will survive this trade dispute. Good, well-managed companies will continue to grow their earnings, and the U.S. will continue to be the main driver of the global economy. But you should expect a bumpy ride along the way.