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Bank of America warns trade wars to dent US corporate profits

Bank of America has cut its 2019 profit outlook for the US stock market’s biggest companies, in the wake of renewed trade tensions between the United States and two key trading partners.

BoA’s head of US equity and quantitative strategy, Savita Subramanian, warned clients that the market’s price has yet to reflect the impact the dispute between the US and China could have on long-term earnings, and trimmed her Standard & Poor’s (S&P) 500 earnings per share (EPS) target by 1.2%, from $168 to $166.

“Globalisation has been a key driver of S&P 500 margin expansion via tax arbitrage, labour arbitrage, supply chain efficiency gains, and the like,” she wrote. “US companies have not been able to exert enough pricing power to offset the rising cost pressures, as evidenced by our Corporate Misery indicator, a macro gauge of margin risk.”

Unsettled investors

Subramanian, who sees the S&P 500 index ending 2019 at 2,900 – modestly ahead of Monday’s close of 2,744 – said that the slight cut to her S&P 500 EPS target could be followed by several further downgrades if US tariffs on Chinese goods continue to increase.

Taxes on Mexican imports — currently due to rise in stages from 5% to 25% by October unless president Trump’s demands for curbs on immigration produce concessions — could trim S&P earnings by an additional 0.6%.

Both Wall Street and other global stock markets retreated in May was as the Trump administration’s move to hike tariffs on goods imported from China unsettled investors, who were then taken unawares as plans to tax all goods from Mexico were suddenly announced. Traders previously assumed that American and Chinese trade negotiators would be able to reconcile thorny intellectual property issues.

The resulting more sombre outlook for both stock markets and the US economy saw a sharp 40 basis point drop in the US 10-year Treasury note rate and subsequent inversion of the yield curve, as expectation grows that the Federal Reserve’s policy since late 2015 of small but regular interest rate hikes may now be reversed because of the more aggressive trade policy.

Subramanian added that it probably leaves defensive stocks as a good investment option in lieu of consumer or industrial companies.

“Stocks with the highest foreign exposure to China, multinationals, and companies with a high percentage of imported [cost of goods sold] have sold off since mid-April when negative headlines re-commenced,” she wrote.

“We estimate the S&P companies only have [about] 1% sales exposure to Mexico, but the imports from Mexico totalling US$350 billion are more than imports from China that the U.S. currently has tariffs on ($250 billion).”

Although BoA  said it prefers US technology and telecommunications stocks to their Chinese counterparts, Subramanian cautioned against bets on the semiconductor market until trade tensions are calmed. Asia-Pacific markets have driven 74% of semiconductor company revenue growth since 2010.

China has recently threatened to retaliate by cutting off the export of rare earths – minerals found in many consumer electronics to the US although as relatively few American companies are major technology product manufacturers the impact of such a move might only be limited.


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