In the week since the announcement of proposed US tariffs on Chinese imports, China’s stock markets have declined sharply, with MSCI China down 6.7% since 21 March.
While the details of potential tariffs remain unknown, near-term volatility may persist. But, even if the initial proposals aren’t watered down, the sell-off appears overdone, with a significant slowing of earnings-per-share growth unlikely, in our view:
- We estimate that the proposed tariffs could trim China’s 2018 GDP growth by 0.1%–0.2% at most. Industrial production and exports for February surprised on the upside, indicating solid fundamentals, which should offset a modest rise in trade-related uncertainty.
- US tariffs will likely target China’s telecom equipment (cell phones), automatic data processing (computers), machinery and appliances, and soft goods (apparel, toys, furniture) exports, since they account for the majority of the US-China trade deficit. These sectors account for less than 5% of index weighting.
- China listed companies’ direct US sales exposure is only around 3%. The three largest sectors within MSCI China, namely IT (mainly internet), financials, and consumer discretionary, account for more than 70% of index weighting and are largely driven by domestic demand, not trade/export.
- We remain watchful for further escalation and assign a 20–30% probability to damaging retaliation. In the risk case, diversification and our counter-cyclical positions should help protect portfolio returns. However, we remain pro-risk and, given favorable earnings and attractive valuations, we prefer Chinese equities within our Asia portfolio.
Note: UBS House View Daily will not be published on 30 March and 2 April 2018.
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