The "Worst Case Scenario": A 10% Tariff On All US Imports & Exports Would Slash S&P EPS By 11%

Over the weekend, Goldman made a material change in its analysis of the US-China trade war, which it no longer sees as simply a negotiating tactic for Trump to extract further concessions from Beijing, but as a policy which is set to go live on July 6, and now comprises Goldman's "base case", to wit:

With this announcement, the likelihood of tariffs on the first $34 billion in goods rises substantially, and implementation by the July 6 deadline looks like the base case. That said, there is still a clear possibility that tariffs could be postponed if US-China negotiations in the interim are productive. If the tariffs take effect on schedule, we expect China to retaliate with tariffs on a previously announced list of US products

Of course, the risk is that once this tit-for-tat regime begins, it may continue escalating indefinitely: recall that on Friday, in order to prevent China from retaliating to the first $50BN in tariffs, Reuters reported the US may impose higher tariffs on an additional $100bn of Chinese imports. This threat did nothing to slow down Beijing's response, however, which retaliated almost immediately with $50BN of its own tariffs. Clearly, if implemented in about 60 days, this second round of trade war will likely be much more damaging for both sides.

Commenting on the potential escalation, Deutsche Bank economists said that the second US tariff list could include big item consumer goods such as phones, computers, TVs etc, which could mean a lot more workers in China and US consumers would be negatively affected. If this second scenario eventuates, the German bank expects China to loosen policy such as tolerating the property and land market boom in tier 3 cities and cutting the RRR twice over the rest of this year to partly offset the potential drags. Keep in mind that even without trade war, last week we learned that China's economy just reportedly "shockingly weak" data, which prompted the PBOC not to hike alongside the Fed.

But the biggest risk is that neither the US, nor China, is so far willing to indicate of a potential "out" to this classical tit-for-tat escalation, which in turn means that the risk of an all-out trade war, one which expands beyond merely the US and China, is growing.

As a result of escalating trade war concerns, Barclays recently estimated the impact in the worst-case scenario of an all-out trade war for US companies across sectors and US trading partners.

In a nutshell, the bank calculated that an across-the-board tariff of 10% on all US imports and exports would lower 2018 EPS for S&P 500 companies by ~11% and, thus, completely offset the positive fiscal stimulus from tax reform.

Furthermore, the impact on exporters which would be directly affected, would be 5%, while that on US companies that import finished goods or inputs would be higher, at roughly 6%. This, to Barclays, highlights the unintended consequences of imposing tariffs given the global nature of current supply chains.

As part of its analysis, summarized in the chart below, Barclays finds that the impact of tariffs varies substantially across sectors, with industrials being particularly vulnerable, and although technology companies have a large amount of foreign revenue, they would not be directly impacted because this revenue is attributed to their foreign subsidiaries. The impact on the energy sector is large but that is mostly because of exposure to trade within NAFTA.

The next chart reveals the exposure aggregated across trading partners. It shows that US companies would be hurt more by tariffs on imports than by tariffs on exports, and that a trade war only on China will affect S&P earnings only by 1.2%. Adding NAFTA nations, Europe and the ROW, brings up the total to just shy of an 11% hit to EPS.

Finally, Barclays adds that while it can not quantify it, a slowdown would also likely hit business sentiment, which would have its own knock-on effect.

In conclusion, the British bank writes that although protectionism was one of the four arrows of "Trumponomics," it did not materialize during the administration’s first year in office, when equity valuations reached an all-time high as sentiment improved with the market’s focus on the other three “progrowth” arrows – tax cuts, deregulation, and fiscal expansion. The risk here is that an unleashing of anti-trade policies and potential of a trade war could reverse the upward trend in valuations, although judging by today's market response, while trade wars were seen as uniformly bearish for risk assets in the morning, as we move to the afternoon, they are becoming increasingly more bullish: in fact, the Nasdaq is already green.