Tariff bomb is back to cast doubt on Asia rebound

Investors and analysts are still scrambling to update their models to factor in a collapse in earnings and a barrage of terrible economic data. Now, one more risk factor is looming large: U.S.-China trade discord.

They are dusting off their trade-war playbook after the U.S. president warned that tariffs would be the “ultimate punishment” for China, bringing back memories from the biggest market slumps of last year: The MSCI Asia Pacific Index plunged more than 5% in two weeks last May, after Trump said he would increase levies on $200 billion of Chinese goods. Three months later, the gauge tumbled again some 5% after he tweeted the U.S. would put an additional 10% tariff on $300 billion in imports from the Asian nation.

While the Asia Pacific index gained on Tuesday, rebounding from a 3.5% two-day drop that was its biggest in more than a month, another go at levies could send it back to its March lows and ignite fears over a financial crisis, analysts say. The MSCI Asia Pacific ex-Japan Index climbed as much as 1% Tuesday (markets in Japan, South Korea and China are closed for holidays).

“The worst case is a cancellation of the phase-one deal and renewed bilateral tariff threats, which neither economies’ recovery efforts can afford,” said Olivier d’Assier, Qontigo’s head of applied research for Asia Pacific. “This will send Asia and the rest of the world into a deeper recession or a prolonged period of near-zero growth at best.”

After an 18% rebound from a trough on March 23, the valuation of the MSCI Asia Pacific Index is no longer cheap. The gauge trades at 13.5 times estimated earnings for the next year, higher than the five-year average of 13.1 times, data compiled by Bloomberg show.

To prepare for a possible U.S.-China trade escalation, D’Assier recommends looking for the least-affected sectors during the worst of the trade war. Factor-wise, it is the time to bet on profitability, low volatility and low-beta large caps with minimal exposure to global supply chains, he added. “It’s time to get defensive again.”

‘Economic Suicide’

To Michael McCarthy, the chief market strategist at CMC Markets Asia Pacific, igniting trade tensions in the current disrupted environment looks like “economic suicide,” but investors “must factor this risk into their assessment of markets” as political considerations may prevail during the U.S. election.

Investors should be alert to polling, McCarthy said. “If the current U.S. president is trailing his opponent, there is higher potential for political factors to outweigh economic considerations.”

That said, there will still be winners if the Sino-U.S. frictions heighten again. The virus disruption has already caused companies to examine their supply frailties. A trade dispute could hasten the process of re-shaping global supply chains and benefit nations such as South Korea, Singapore, Thailand, Cambodia and Vietnam, he said.