Nobody Knows Where to Take Shelter From Trump’s Trade War

(Bloomberg Businessweek) -- During months of heated rhetoric surrounding trade and tariffs, Wall Street strategists and advisers largely assumed it was all just brinkmanship. But suddenly more of them are advising investors to go defensive. Easier said than done in 2018, when every global market is intertwined. S&P 500 companies got 43 percent of their sales from overseas in 2016, according to a report from S&P Global Inc. “There is a lot of debate on what is a defensive sector,” says Emily Roland, head of capital markets research at John Hancock Investments.

Some say you should shift assets to smaller companies. They're more domestically oriented and should provide insulation from a trade war, the thinking goes. Others hail consumer staples. If the economy slows, people will still need toothbrushes and diapers, right?

It turns out none of this is clear-cut. Flash back to early March, when Donald Trump announced tariffs on steel and aluminum imports. The small-cap Russell 2000 index began to take off vs. the S&P 500 as cash shifted to smaller companies. Now, strategists across Wall Street are pointing to flaws in the “small companies are safer” thesis. In a note to clients, Maneesh Deshpande of Barclays Capital highlighted small-caps' heavy reliance on imports. Mike Wilson, Morgan Stanley's chief U.S. equity strategist, wrote that the stocks' prices may have gotten ahead of themselves. In his regular conversations with the management teams of smaller companies, Matthew Litfin, portfolio manager of the Columbia Acorn Fund at Columbia Threadneedle Investments in Chicago, has sensed worry. “Small-cap CEOs are newly concerned about the trade war,” he says.

Flows into the largest exchange-traded fund tracking small-cap stocks, the iShares Russell 2000 ETF, also reveal a change of heart among investors. From March through the end of May, the $47 billion fund saw $4.6 billion in net inflows. Since then, more than a quarter of that cash has fled.

Then there's the debate about whether a trade war is inflationary or deflationary. Maybe it increases the costs of imports in markets where unemployment is already low and pushes prices up. Or maybe that's counteracted by a slump in growth. Jim Paulsen, chief investment strategist at Leuthold Group LLC in Minneapolis, says investors have to take into account the possibility of stagflation—an environment with rising inflation and low growth. “I'd go with a barbell approach,” he says. “I would definitely have the inflationary beneficiaries—energy, materials, industrials—but I'd also put in some pure defensives—utilities and staples.”

Or maybe what works best in a trade war is what worked before one: tech. Roland says tech companies are actually the new defensive play. People are too attached to their iPhones to give them up easily. Add them to the list with toothbrushes.

If all this is giving you the idea that maybe the simplest move is to stay diversified, well, that's one reason the index fund business is booming. And if ever there was a time to embrace the idea that stocks move unpredictably, in what economists call a “random walk,” maybe it's at a moment when it seems the world can turn on a single random tweet.

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net, Howard Chua-Eoan

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