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How Can Investors Guard Wealth Amid Rising Protectionism?

Christian Armbruester, 20 March 2018

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What should investors do when thinking of the rise of some trade barriers, as appears to be on the cards in countries such as the US? A UK-based family office considers some ideas.

There is a spectre, a spectre of protectionism rising around the world. The push by President Donald Trump to slap tariffs on imported steel and aluminium, which has provoked moves by the EU to put levies on some US imports, raises fears about a trade war. Economists famously disagree about many things but it is said that on international trade, the case against protectionism is supported by the overwhelming majority of economists – uniting a Milton Friedman with a Paul Krugman. Whether that consensus still holds is an open question; we have seen the rise of critiques of “neo-liberalism” and globalisation (in plain English, free trade and free market economics) from a number of sources over recent years. The financial crisis of 2008, even though it was arguably more about the sins of government than of free markets gone amok, has led many to think that the case for unfettered free trade that seemed to reign supreme after the end of the Cold War, was waning. 

With all that in mind, the idea that protectionism could be on the rise may cause high net worth individuals and their advisors to re-think their investments and shape of their portfolios. How should the issue of trade affect one’s thinking? To consider such questions, Christian Armbruester, CEO and founding principal of UK-based Blu Family Office, offers some thoughts. The editors of this news service are pleased to share these ideas with readers and invite responses. They can email tom.burroughes@wealthbriefing.com

The views of guest contributors are not necessarily shared by this publication’s editors.

With all the talk about tariffs and a looming global trade war, what can we do as investors to protect ourselves and are there any investment ideas to take advantage of potential opportunities?

There is always a trade and one can always take out insurance. So, to explore our options, let us first examine the effect of any such tariffs. As we all know from attending our very first economics class, trade wars are bad. For one, they restrict trade and two, they divert resources to inefficient industries (otherwise why protect them). Indirectly, protectionist action in one area usually affects trade in other industries and, for the most part, there really are no winners. Which is why we rarely have trade wars, but Trump politics is the topic for another article.

So, how can you protect yourself from reduced trade, fear of contagion and a general slowdown of global growth? Increase your credit exposure and reduce equity risk are the obvious choice, but that will also go hand in hand with lower expected returns. Something to bear in mind, if the trade wars don’t turn out as bad as expected. 

What about investment ideas to benefit from the proposed actions? With US steel, aluminium and auto makers under the protection of the US government, and European companies bearing the brunt of increased prices, could we buy one set of companies and short the other? The following chart displays how such a trade would have looked in anticipation of the tariffs and after the announcement in regard to the steel sector.  

Chart: Steel – Comparing the performance of a group of European versus US Steel companies


 
Source: Bloomberg

From the chart we can clearly see that European steel companies have underperformed their US rivals since the beginning of February. The problem is of course, when were the tariffs priced into the shares, e.g. did we already know they were coming and hence the shares started moving months before the actual announcement? The second problem is, we don’t know what the market is now pricing in going forward, e.g. is that it now, and pending any changes, will the shares just stay where they are as far as tariffs are concerned?  

The other thing we don’t know, is how long these trade impediments will stay in effect. Already there have been announcements that some parties will be exempted and, with the EU announcing that they will charge tariffs on US imports of Bourbon, Levi Strauss and Harley Davidson, the lunacy of the whole idea may become clearer and cooler heads could prevail. 

Another investment idea could be to buy some options on the companies affected in anticipation of increased volatility. With the almost daily rhetoric of tariff on or off, which industries and what country may or may not be exempt, it might just make the shares a bit more active until we see a greater clarity.  

Chart: Volatility of a group of US and European steel companies
 

Source: Bloomberg

As the chart makes clear, the volatility has surely increased in the shares affected by the tariffs. The success of the trade will clearly depend on getting the entry level right as when to buy volatility. But the nice thing about buying options is that you can only ever lose the amount of the premium you buy. As such, at least we know exactly how much we are risking on the trade.  

Overall, I think the main moves in shares and the industries affected on this round of tariffs is done, and it will be hard to make money in any trade unless there is further information or escalation. It might make sense to speculate which shares or industries could get hit next with tariffs from either side. “Buy the rumour, sell the fact” is a well-known trading strategy. But my favourite strategy is probably to do absolutely nothing and wait for the fall out and carnage to play itself out. As we know, there will only be losers from this exercise and waiting to buy when things are at their most bleak has historically proven to be the most successful trading strategy. So, go ahead Trump, do your worst.  

 

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