This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features co-authors, Wes Flanigan, Senior Research Analyst for ClearRock Capital and Henry Hagenbuch, Director of Growth.
On March 8th, President Trump officially raised tariffs on steel and aluminum imports, imposing 25% on steel and 10% on aluminum. His reasoning: foreign countries’ current trade practices with the US are a threat to national security. Despite GOP dissent from the likes of Rep. Kevin Brady and Speaker of the House, Paul Ryan, as well as the subsequent resignation of Trump’s top economic adviser, Gary Cohn, this marks an unprecedented turning point in US trade policy, away from bluster and brinksmanship and towards actual protectionist measures. In our most recent weekly investment committee meeting, we discussed how this may affect the global economy and whether it would have a negative impact for investors.
Won’t Spark Global Recession
There is talk that President Trump’s efforts to level the international trade playing field could spark a trade war, potentially resulting in a global recession. We do not believe there will be an immediate effect on the world economy. Together, steel and aluminum imports account for only about 2% of world trade, according to Capital Economics research. The effect on emerging markets is also unlikely to have a major impact. For investors, in the case of emerging markets, a broad-EM ETF such as, the iShares MSCI Emerging Markets ETF (EEM) is a position where impact is likely to be small.
Why? The first country that comes to mind as far as being in President Trump’s tariffs cross hairs is China. After all, Trump has criticized China for flooding the market with cheap metals in the past. China, however, does not even make the top-10 list of steel exporters to the US. In fact, two of the top-4 exporters of that same list were recently carved out of the proposed tariffs, Canada and Mexico. Therefore, it is not likely that these tariffs would have a meaningful effect from the perspective of the larger trade players and steel exporters (see chart).
Risks Still Exist
One risk these tariffs do pose is that it could prompt a broader shift towards protectionism, whichmay be a reason for the recent volatility in emerging markets. The most affected EMs would be a couple of Middle Eastern countries, particularly Bahrain, who exports large amounts of aluminum. Even then, the negative consequences of the tariffs could be delayed or avoided via legal challenges or exemptions (the latter seems likely for Gulf States, who are important strategic partners of the US).
Another risk is that these tariffs could prompt retaliatory action. Before Canada was carved out, they announced that they would take measures to protect their domestic trade interests. Brazil has echoed the same sentiment, and the EU has reportedly discussed possible targets for retaliation as well. Other governments may also move to protect their own steel industries, a legal move under World Trade Organization terms.
Why MLPs Could Be Pressured
There has also been some chatter in the markets that master limited partnerships (MLPs) could come under pressure on the heels of these tariffs because of their industry reliance on steel imports. ETPs such as, The Alerian MLP ETF (AMLP) or the JPMorgan Alerian MLP Index ETN (AMJ) are investment products that could be impacted. For example, almost two-thirds of the constituents within the Alerian MLP Index (AMZ) (which AMJ tracks) is comprised of pipeline companies.
However, we do not believe this will result in a material adverse effect for that sector. A February 2018 MLP market update by Goldman Sachs Asset Management highlights that while approximately half of the steel used in pipelines is imported, a significant portion of this steel comes from Canada and Mexico. While both countries remain exempt from the proposed tariffs, this could change as the NAFTA negotiations continue. Moreover, only 56% of US pipelines are primarily composed of steel (see chart). Goldman argues that the modest cost inflation could be offset by charging higher rates to pipeline customers and the expectation that the sector’s CAPEX will decline by over 50% through 2020 according to Wells Fargo, further refutes the idea that tariffs will adversely affect these markets.
It is safe to assume market volatility will persist, especially since the 15-day window for US firms to win exemptions from this mandate is quickly closing. Either way, we believe the best course is to continue to monitor the situation closely and avoid making kneejerk investment decisions based on headlines alone.
At the time of writing, ClearRock clients currently owned EEM, AMLP, and AMJ. ClearRock is an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho. For a full list of disclosures, please click here.
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