Exchange-traded Funds  

Using ETFs to position for trade war events

  • Describe how the US-China trade war started and three possible scenarios that could develop.
  • Identify how exposed various equity indices, tracked by ETFs, are to an escalating trade war.
  • List which sectors and company sizes are more or less exposed to the trade war.
Using ETFs to position for trade war events

The fourth quarter of 2018 was characterised by a correction in developed market equities and a big uptick in volatility. 

At least some of this uncertainty stemmed from escalating trade tensions between the US and China. 

The so-called ‘trade war’ began in January 2018 when the US placed a 30 per cent tariff on foreign solar panels, to be reduced to 15 per cent after four years (China is the leading producer of solar panels), and a 20 per cent tariff on washing machines for the first 1.2m units imported in the year.

This set the scene for a year of tariff and counter-tariff manoeuvres by both China and the US. 

In September the US announced it was imposing 10 per cent tariffs on $200bn (£155.1bn) of Chinese imports, which would increase to 25 per cent by the end of the year.

In announcing the new tariffs, US President Donald Trump threatened further action, stating: “If China takes retaliatory action against our farmers or other industries, we will immediately pursue phase three, which is tariffs on approximately $267bn of additional imports.”

The next day China did retaliate by putting in place 10 per cent tariffs on $60bn of US imports. 

However, at the start of December, a 90-day truce was signed, postponing the planned tariff increases. Discussions around Chinese market access restrictions and intellectual property rights are now taking place, but there remain many areas of dispute and disagreement, with the countdown already started.

Investors navigating the trade war face substantial uncertainty, particularly around whether hostilities escalate to encompass other nations and trading blocs.

Three scenarios

There are three basic scenarios that could develop from this point. 

First, the trade war between China and the US could ease, with the US and China signing a trade deal based on mutual agreement.

In this scenario, those stocks mostly exposed to the current trade tensions might recover most. 

The second scenario is that the trade war could further escalate but be contained to those two countries, in which case we might expect to see more tariffs and China retaliating further with restricted market access, travel bans and possible reductions in its holdings of US Treasuries.

The third scenario sees a trade war both escalating and going global, with US industrial policy and protectionism triggering European involvement (tariffs on cars, for instance).

The onset of a wider tariff arms race could severely interfere with global trade.

Investors expecting the first scenario will be eager to see which stocks may indeed have owed most of their recent volatility to trade tensions.

Investors expecting 2019 to be characterised by either scenario two or three might, however, consider how they can position their portfolios to cushion the downside of an escalating trade war.

For exchange-traded fund (ETF) investors in particular, analysis of how exposed particular equity indices are to an escalating trade war, and therefore whether to consider potentially reducing exposure to those indices most at risk, could prove useful.