Amidst Trade Wars: Implications and Trading Recommendations

When two or more warring economies impose higher and more extensive tariffs against each other, businesses in the affected industries bear the brunt of government actions.

For example, when the United States imposed a 100% tariff on Chinese EVs, American dealerships that sold Chinese EVs had to double their prices on new EV imports. Consequently, they faced dwindling demand.

Chinese vehicles are supposed to be more affordable or offer greater value than homegrown brands and electric automobiles from other countries. If they become twice as expensive, they immediately lose their edge.

With crawling inventory turnovers come higher storage and related costs, which dealerships must bear or pass on to their consumers, making prices progressively less attractive.

If the trade war escalates and becomes protracted, the distributors of Chinese EVs may have no choice but to close—and just like that, an industry segment gets wiped out.

The situation is no better on the other side. Immediately upon the imposition of 100% EV tariffs, manufacturers of these electric vehicles will deal with order cancellations, leaving thousands of assembled units unable to leave the line and millions (maybe billions) of dollars in capital tied up in inventory.

As their products become drastically more expensive to buy for their American dealers and customers, they will lose a significant chunk of their markets.

Of course, they will try to divert their oversupply to other markets, but this takes time, and realising the positive effects of such a move can take a while. As they cultivate other markets, they must bear the losses of their cars not rolling out of their assembly plants.

But these trade wars have winners, too. The restrictions on Chinese automobile imports mean American, Japanese, and European EV brands can potentially capture the orphaned Chinese EV market.

Trade wars have indirect impacts as well. As mentioned earlier, the 100% increase in Chinese EV tariffs prompted China to impose new tariffs on major U.S. exports to China. China can also ban the export of its minerals to the United States.

The United States is import-reliant on China for several minerals, including gallium, germanium, antimony, and graphite. The first two are important raw materials in the manufacture of semiconductors.

This means the U.S. semiconductor industry will eventually feel the pinch of the trade war that initially involved only Chinese EVs.

Antimony, meanwhile, is used in the manufacture of bullets and weapons, and a ban on antimony exports to the United States will have negative implications on the U.S. defence industry.

More importantly, graphite is essential to the production of electric vehicle batteries. Therefore, even if U.S. car manufacturers can potentially capture a larger market share of the U.S. EV market, they may also suffer from the scarcity or the higher cost of importing graphite.

Traders may not be directly implicated in trade wars, but they are similarly afflicted. However, in economic turmoil also lies opportunities.

If you understand the forces at play and how they will affect specific industries and assets, you can make some lucrative trades amidst the turbulence and minimise potential losses through defensive tactics.

• Rotation and reallocation. Considering only the 100% tariff imposed by the U.S. government on Chinese EVs, you can infer that automobile dealerships that distribute Chinese EVs will be hit hard. You may also be able to predict China’s retaliatory moves. Thus, it behooves you to take a defensive stance by closing your positions on or shorting assets that will be adversely affected.
• Currency hedging: You can also hedge against the expected turbulence by opening a position on currency pairs that can offset the risk in other parts of your portfolio.
• Using options: Use protective puts to limit downside risk on assets likely to be negatively affected, but you’d rather not let go. You can also use covered calls if you believe an asset’s prices are range-bound.
• Pairs trading: A pairs trade is opening a long position on one asset and matching it with a short position on a highly correlated asset. You implement this strategy when you notice a discrepancy in the correlation between the two assets but are confident that the divergence is temporary. When your prediction comes true, and the positive correlation between the two is restored, you will profit.

Trade wars are harmful, killing businesses, ravaging industries, and slowing GDP growth. However, they can also be opportunities for traders.