The global trade war initiated by U.S. President Donald Trump is ramping up. On July 1, 2018, the U.S. began imposing a 25% tariff on Canadian steel and 10% tariff on aluminum. President Trump has also slapped China, Russia, Mexico, and the European Union with imposing tariffs. So far, each country has retaliated tit-for-tat, but fears of an all-out trade war, and financial crisis, are becoming an all too real scenario. What should investors do if a global trade war with the U.S. undermines the global economy?
Safe Haven Assets
Traditionally, one of the first places investors turn to during a trade war and financial crisis are safe haven investments like gold, silver, and the U.S. dollar. But investors usually turn to these safe haven investments at different times. That’s because precious metals and the U.S. dollar tend to have an inverse relationship, when one does well the other doesn’t.
For example, when the U.S. economy is doing poorly, the greenback usually slips, and investors turn to precious metals. When the U.S. economy is chugging along, the dollar is strong and precious metals slide.
Gold hasn’t really caught on yet and has been trending lower since March, sitting near a support level of $1,240 per ounce. The U.S. dollar on the other hand has been bullish over the same time frame with one U.S. dollar now worth $1.31 Canadian.
As the world’s biggest economy, the U.S. economy is expected to remain strong with the U.S. dollar outperforming other currencies, especially if there is a trade war, which would not be good for gold.
That said, there are points in history when the U.S. dollar and gold run in step. Right now, political uncertainty and nosebleed valuations for U.S. stocks (currently overvalued by 103%) bodes well for gold.
China, the world’s second biggest economy, has long been an attractive place for investors. But in the event of a major trade war between the U.S. and China, it might make sense for investors to consider emerging markets.
Many emerging market economies, especially Brazil and Russia, are not as susceptible to trade wars as China and South Korea are. Valuations for emerging markets are also cheaper than their U.S. and Canadian peers.
On top of that, should a full-blown trade war erupt between the U.S. and China, emerging markets should benefit if companies move their manufacturing operations out of China.
What about Small Cap Stocks?
In a trade war, many investors think they should invest in small cap stocks. After all, they’re small companies and rely on domestic sales more than their large cap peers do. Small cap stocks get only around 20% of their revenue from foreign sales where large cap stocks rely on foreign markets for 30% of theirs.
A trade war would, in theory, hurt small caps less. Meaning, their share prices should benefit from a trade war. This isn’t always the case though. Small cap stocks can get hammered in a trade war because they have lower margins and do not benefit from foreign subsidies.
This means some small cap stocks will be more exposed to a trade war than many large cap stocks.
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