US stocks attractive despite impending trade war

Despite the ongoing trade war, US stocks could still remain the place to be for investors. However, amid small-cap outperformance, it may make sense to target different areas of the US stock market at different points of this trade conflict.

US stock market

The US-led trade war is, and will remain to be, the biggest determinant of market sentiment. Friday marks the opening salvo of that trade war, with both the US and China implementing a 25% tariff on $34 billion worth of goods. The impact upon global markets is likely to be profound, with Chinese markets in particular suffering heavy losses in anticipation of the loss of a major export market. However, while there is a distinct threat to US stocks, this could also present an opportunity for those investing in US markets.

Looking at the breakdown of US trade with China and the EU, it is clear that there is a substantial discrepancy between the trade of goods, driving a wide trade deficit. However, it is also clear that the US has a notable, albeit smaller, trade surplus in services which should not be ignored.

The breakdown of goods trade shows us that there is a huge discrepancy between the amount the US exports and imports to China and the EU. This is clearly what US President Donald Trump is looking at when entering this current trade war. It also justifies the $200 billion worth of Chinese goods that Trump has targeted for the next round of tariffs. Clearly, with China importing just $130 billion of US goods, they will be unable to match the value of goods being targeted by the US.

That being said, the Chinese have been able to soften the blow of any such measures, with the devaluation of the yuan helping counteract the imposition of tariffs on exports. With the yuan trading 6.5% higher than the March low, we are going to see US exports look more expensive to the Chinese, while Chinese products are 6.5% cheaper to US consumers. Whether the devaluation of the yuan has been orchestrated by the Chinese government is arguable. However, it is clear that markets see a major threat to the Chinese economy, and looking at the trade balance, China in particular has more to lose.

What is clear is that the US has the ace cards. Their relative weakness in trade positioning is in fact their advantage, with higher tariffs meaning US consumers are more likely to shift spending towards domestically produced items. However, there is no doubt that a trade war will ultimately make both sides lose out. This means that while we could see selling across European, US and Chinese stocks, the US is likely to be less exposed, particularly in relation to China. European stocks, on the other hand, have performed comparatively well since the trade wars first started in early March, partly due to the decline in EUR/USD.

While the short-term uncertainty caused by the trade wars is no doubt a concern in global markets, the outcome is likely to be positive for the US in particular. Through greater access to EU and Chinese markets, there is reason to believe that internationally-focused US firms will benefit from the outcome of this current stand-off.

With the corporate tax cut leading to a significant rise in US business investment, and US gross domestic product (GDP) expected to hit 4% by the end of the year, there is reason to believe that the US is the place to be for investors. While the trade war remains one of the biggest drags on sentiment, there's some suggestion that perhaps internationally-focused US stocks may not be the ideal investment currently. With that in mind, we have seen a significant outperformance in smaller stocks against larger corporations. Below we can see the major and consistent outperformance in the Russell 2000 versus the S&P 500 since March. This has driven a strong deterioration in the spread between the two indices, which trades around an eight-month low. Finally, looking at the relative strength of the two, we can see that the Russell 2000 still seems to have the upper hand. Watch for a break above the peak set on Friday to signify a potential shift.

It’s clear that the US is the place to be, with growth expected to still remain high despite trade fears. Although, for now, it seems to make sense to remain long on smaller, domestically focused stocks. However, should we see Donald Trump obtain a better trading environment for US stocks, the investment focus should shift back into the internationally focused stocks within the S&P 500 and Dow Jones.

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