Now that US president Donald Trump has put into effect some of his more controversial campaign promises, such as on climate change and immigration, more protectionist trade measures seem inevitable.
Yet Asian equity fund managers might themselves raise eyebrows with their views on what to buy and sell as a result of his actions.
On the recommended list are Chinese oil companies and other ‘old economy’ stocks, Asian firms with US shale gas interests and, perhaps most surprisingly, certain select big exporters. However, Indian pharmaceutical and IT names, and certain manufacturers elsewhere in the region, are seen as vulnerable to Trump’s plans to impose import taxes and raise tariffs.
Moreover, equity specialists argue that if developed economies were to adopt more protectionist policies, Asia must rise to the challenge by accelerating the long-running shift from manufacturing to services. “The delta there could be quite dramatic,” noted Josh Crabb, head of Asian equities at Old Mutual Global Investors.
Big tax impact
It seems inevitable that goods entering the US would be subject to higher taxes as the country tries to cut its trade deficit, said fund managers. That could have a big impact on Asian companies’ short-term earnings and longer-term strategy, as the region accounts for about one-third of the world’s exports.
China in particular is caught firmly in the crosshairs since it accumulated a $319 billion trade deficit with the US between January and November last year. The deficit has been on a rising trend for years.
Two taxes are under examination and the most likely to come into force is the proposed border adjustment tax, argued Crabb, Omgi’s head of Asian equities (pictured left).
The Republican-led Ways and Means Committee has been working on it for several months and is proposing a 20% import tax and zero export taxes. That would effectively give exporters a 7% to 14% subsidy, according to research by Chinese investment bank CICC.
Crabb told AsianInvestor the measure stood a good chance of getting past the World Trade Organisation, as other countries operate similar taxes.
Trump’s second proposal is to impose higher import tariffs – as he threatened Mexico with on Thursday – and penalise US companies trying to offshore their manufacturing operations.
This latter proposal may persuade more US companies to stay home. But it could also lead to retaliatory measures, said Crabb, although he suggested Trump was using the threat as a bargaining tool with the Chinese.
Shale sector favoured
Crabb’s approach has been to look for Asian companies that have been buying up cheap assets in the US. He is particularly keen on companies and sectors tied to US shale gas.
Many producers of plastics and thermo-plastics will gain from a new shale gas capital expenditure cycle, he said. “They’re also benefiting from a greater focus on higher environmental standards and [manufacturers] shifting away from materials like steel.”
South Korea and Taiwan are both likely to face significant headwinds given their export-driven economies, said Crabb. But he also argued that a broad-based sell-off in stocks from those two countries should create good buying opportunities for companies that have invested in the US or are part of the shale gas value chain.
“Korea has been very fortunate because the US has always been happy to buy its products,” noted Crabb. “It can still compete, but it just needs to get a lot better at what it’s good at.
“It may also need to re-examine whether it needs such a high current-account surplus and what more it can do in the way of corporate restructuring, he added.”
Not all bad for Asian exporters
Surprisingly, certain export-orientated Korean companies are quite well placed to weather a 10% tax on their revenues, according to research from Daiwa into the effect of such a levy on their profits.
Analysing 43 Asian companies that derive more than 20% of their revenue from the US, the Japanese broker-dealer found that chip-maker SK Hynix and Hyundai Motor were best placed, with only a -2.3% gross profit sensitivity.
At the other end of the scale was Hong Kong conglomerate Li & Fung, with a -58.1% gross profit sensitivity, and Singapore engineering group Sembcorp Marine on -46.5%.
Meanwhile, Crabb recommended exiting Indian pharma and IT companies. “The IT companies are basically exporting to the US financial services sector, and they’re easier jobs to repatriate because the pay differential isn’t that great,” he said. “This isn’t the case with low-end manufacturing jobs, which will be far harder to bring back.”
He was referring to Trump’s stated aim to get American companies to bring offshore manufacturing operations back onshore.
Mansfield Mok, who runs the New Capital China Equity Fund at EFG Asset Management, agreed that US import taxes were likely in some form. He has been repositioning his portfolio since early December, boosting his cash position to 8% in an early defensive move before winding it back to 5%.
Chinese oil companies
The proposed US trade policies are likely to push the dollar ever higher, and Mok acknowledged that this was generally not good for Asia. However, Mok (pictured below right) has been playing the trend by investing in Chinese oil companies, which have dollar-based revenues.
“The sector is still trading at a discount to DCF [discounted flow analysis], at $55 per barrel,” he noted, “and the sector has a second good tailwind now Opec [the Organisation of Petroleum Exporting Countries] is underpinning prices by cutting supply.” In December Opec members agreed a deal to cut production by 1.8 million barrels a day.
DCF is a method of valuing assets using the concepts of the time value of money, whereby future cash flows are estimated using cost of capital to give their present values.
Mok also believes China will respond to the US trade proposals by accelerating its supply-side reforms and state-owned enterprise restructuring – thereby creating upside in ‘old economy’ stocks.
“Parts of the industrial sector have bottomed,” he noted, “So we’ve rotated out of new economy stocks, which are trading at very expensive valuations, and into select old economy names.”
One sector he favours is cement, given that many stocks are trading below replacement cost, which denotes the cost required to establish a greenfield cement plant.