Using ETFs to position for trade war events

In the case of both the MSCI Europe and DAX 30, trade as a share of GDP for the underlying countries is over 80 per cent (Source: OECD/World Bank based on full year 2016).

Now let’s look specifically at China, keeping in mind that ETFs providing exposure to the domestic Chinese equity market can be bought and sold on the London Stock Exchange (LSE) just as easily as ETFs providing exposure to UK, German, European, US or global equity indices.

China’s key domestic equity index is the CSI 300, which tracks the largest 300 stocks by market capitalisation listed on the Shanghai and Shenzhen stock exchanges.

Here we find that 90 per cent of revenues generated by CSI 300 companies are linked to domestic China activities, with less than 2 per cent of revenues linked to earnings from the US.

Figures for the MSCI China index, which contains both A-Shares and H-Shares (which are listed in Hong Kong) are similar, with 93 per cent of revenues generated domestically within the index. 

So what can we take from these numbers?

Looking specifically at US sectors, we find that some sectors may be cushioned from an escalating trade war.

They demonstrate that, at least from a revenue perspective, US equities are more exposed to retaliatory tariffs than Chinese companies are to tariffs imposed by the US.

The sharp correction China has suffered, from a price-to-book perspective, versus the US market may not be entirely justified – at least when we consider it in terms of a potential revenue impact of a trade war scenario currently priced in by markets.

It may be that China could end up being less impacted than the US in a further escalating trade war scenario, or actually recover if the situation improves or remains uncertain.

The analysis also shows that European companies are significantly exposed to a trade war should it escalate beyond a bilateral US-China dispute as per scenario three.

Focusing on sectors and company size

As well as looking at which country or regional indices are more or less exposed to an escalating trade war, it is also instructive to look at which sectors and which types of indices, in terms of those tracking large or smaller companies, tend to be more or less exposed – again, keeping in mind that ETFs tracking specific sectors of the economy, or targeting company sizes, are easily traded on the LSE. 

Looking specifically at US sectors, we find that some sectors may be cushioned from an escalating trade war.

The US real estate, utilities and, to a lesser extent, consumer discretionary sectors are all relatively more insulated from a trade war, for example.