The recent reactionary tariffs placed on Chinese imports have taken their toll on stock gains. Some analysts are expecting the impact of this “trade war” to be felt in broader aspects of the economy.
Morgan Stanley analyst, Michael Wilson wrote in Note Monday, “the potential cost headwinds of 25% tariffs on all Chinese exports to the U.S. could be in the range of 1.0-1.5% of the index’s net income,But demand destruction and ailing confidence increase the potential impacts well beyond just higher costs and would likely lead to an economic recession in our view.”
Last week, the rate tariffs on about $200 billion worth of Chinse imports was raised up to 25%. It was also announced that there would be further levies on another $300 billion worth of imports. President Trump believes that China “broke the deal” that both sides had been working towards over the past few months. Thus, the use of tariffs to extract concessions.
China retaliated by announcing plans to set a tariff rate reaching the high twenties on a part of 60 million dollars’ worth of US imports. This would be effective from June 1.
“The news sent contracts on the Dow down more than 500 points in pre-market trading.”
Wilson has continually highlighted the possibility of an “earnings recession”, or a contraction in S & P 500 companies’ bottom-line growth. With this in mind, he posited that S&P 500 as probably overvalued at its near-3000 level which as approached earlier this year.
“While last week’s correction helped move the risk-reward closer to balance, we think there is likely more downside than upside based on our high conviction view that (next twelve month) earnings expectations remain too high by 5-10%,” Wilson said.
As concerns about the “trade cold war” grew, The S&P 500 posted a weekly loss of 2.18% last week. Regardless of this, the index was still up about 15% for the year-to-date.
“But earnings recession aside, an increase in the prospect of increased trade tensions has also pulled up the probability of a full-blown economic recession”, Wilson said.
“There are many signs that the risk of a recession in the next 12 months is rising,” Wilson said. He highlighted proprietary indicators that Morgan Stanley’s Cross Assets team tracks. He said that it “officially tipped over into the ‘downturn’ phase which has always preceded an economic recession” last month.
“While an economic recession doesn’t always ensue after the indicator signals downturn, on average equities tend to underperform treasuries over the next twelve months by about 6%, indicating we have little upside until either price fall back to more reasonable levels or this indicator reverses,” Wilson said.
Other analysts are beginning to see the potential damage that a China-US trade war can cause for both countries. In an analysis by SociétéGénérale’s Klaus Baader, he posits that “if the current tariffs remain in place, GDP “can be expected to be hit to the tune of 0.5% in China, 0.25% in the U.S., and 0.15% globally.”
“If the U.S. levies tariffs on all Chinese goods, and China retaliates, these losses could easily double,” Baader said. “Confident effects and financial market reactions also argue for a downside balance of risks.”
The prospects of a near-term trade deal are looking very unlikely, as talks have reached a deadlock phase. However, a compromise reached by both parties would reverse the irregularities in trading as seen over the past few months.