Asset Allocation 3Q19: Navigating trade war


We continue to maintain a preference for equities over bonds
Chief Investment Office01 Jul 2019
Photo credit: AFP Photo


True to form, global equities staged an impressive rebound during the first four months of 2019 as the timely combination of a dovish Federal Reserve and a resurgent Chinese economy reignited “animal spirits” after December’s carnage. But as the saying goes, “nothing lasts forever”. The high-octane rally in global equities came to an abrupt halt as US-China trade tension reared its ugly head again in May and triggered a broad-based retreat in risk assets.

Since 2018, we have maintained the view that rationality will eventually prevail with the trade war seeing a peaceful resolution. Not anymore. Recent rhetoric between the US and China suggests that the key issue at hand is no longer about trade per se. It is about the fight for strategic and technological dominance on the global stage. Even in the event that US and China reach a resolution in the coming months, the calm will only be transitory. At the end of the day, there are no easy solutions for deep-seated issues surrounding intellectual property and protectionism. Undercurrents and mistrust will linger for the foreseeable future.

So in an “all-out” trade war, what will the impact on the S&P 500 Index be?

Faced with heightened tariffs, Chinese companies exporting to the US market will try to pass on the bulk of these costs to US importers while absorbing part of it. According to DBS economists, real US GDP growth will be reduced by 0.6%pts to 1.9% in 2019. Against this backdrop, we expect:

  • US capex: Based on our model-based analysis, an “all-out” trade war will bring the year-on-year 12-month trailing capital expenditure of S&P 500 companies to almost zero (vs 12% growth in 1Q19).
  • US earnings: Based on a worst-case scenario, our model-based analysis suggests that S&P 500 earnings could be reduced by 3%pts in 2019.
  • US valuation: Estimating the valuation impact of an “all-out” trade war is definitely more of an art than a science. We conducted an analysis on this last year in our CIO Perspectives – Trade war: From rhetoric to reality (4 July 2018)?

Back then, we drew reference on the US steel tariffs of 2002 and concluded that in the event of an “all-out” trade war, US equities could undergo correction and trade at 14% discount to its long-term median. Our view is unchanged.


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