Tuesday 21 May 2019

Investopedia/Matthew Johnston: Why the Trade War Won’t Crush U.S. Corporate Profits

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Why the Trade War Won’t Crush U.S. Corporate Profits

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By Matthew Johnston
Updated May 21, 2019

Trade tensions between the U.S. and China will intensify with fresh tariff increases from both sides set to take effect on June 1, a cause of growing concern on Wall Street. But a new report from Goldman Sachs suggests the damage to U.S. corporate profits will be minimal. While U.S. corporations are exposed to China, Goldman says the exposure is not enough to warrant any serious dent to profits. Firms will be able to dull the harmful effects of the tariffs by moderately boosting prices to consumers and adjusting their supply chains.
Why the Trade War Won't Kill Corporate Profits

(2 Scenarios)

1. 25% tariff on $200 billion of imports from China

- 2% EPS revision, can offset with less than 1% price increase

2. 25% tariff on all imports from China

- 6% EPS revision, can offset with a 1% price increase

Source: Goldman Sachs
What It Means for Investors

The very trade imbalance between the U.S. and China that the Trump administration is hoping to rectify highlights the exposures to China that U.S. companies face. With exports to China less than imports, most of the damage will come from higher import costs than from lost sales.

In terms of sales, S&P 500 companies generate a majority (70%) from within the U.S. while only 2% of their sales are generated explicitly from Greater China. To be sure, when it comes to imports, 18% of total U.S. imports come from China, according to Goldman Sachs. But Goldman says companies take steps to mitigate any impact.

While a 25% tariff on all imports from China could lower current consensus estimates of S&P 500 earnings per share (EPS) by as much as 6%, this severe scenario is unlikely. The more moderate scenario depicted by the bank represents the current reality: 25% tariffs on $200 billion of imports from China. Under this scenario, consensus EPS estimates could be lowered by 2%.

And in both scenarios above, U.S. corporations would be able to mitigate the negative effects of the tariffs through price increases and substitution of Chinese suppliers with others. A less than 1% increase in prices would be enough to offset the 2% decline in the consensus EPS estimate, according to Goldman Sachs. And a 1% price increase would largely offset Goldman's worst-case scenario.
Looking Ahead

Similar to Goldman Sachs’ optimism about U.S. corporate profits, veteran economic analyst and CEO of Cornerstone Macro, Nancy Lazar, is optimistic about the prospects of the U.S. economy despite escalating trade tensions. No doubt, “Trade wars are bad,” she told Barron’s. “But longer-term, there’s a strong case that investment is moving back to the U.S. due to higher costs in China, coupled with our lower corporate tax rate.”

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