Roughly around the time David Rosenberg “calculated” the contribution of the Fed’s unprecedented monetary policy on the S&P (which he estimated at roughly 1,000 points, which is about half of what Albert Edwards believes the Fed “added” to the stock market), Bank of America was out with an analysis, this time looking at the contribution “globalization” has had on global corporate margins. The reason: an attempt to handicap the potential risks from all-out trade war which leads to the unwind of “globalization”, by which we assume the bank refers to global supply chains, JIT procurement, lower wages for US-based workers, grassroots anger with the status quo, and so on.
As BofA’s Savita Subramanian writes, the key risk to equities following Trump’s election “was a shift from globalization to protectionism, which could choke off growth for a very global index – one-third of sales are from overseas, and indirect exposure via commodities, FX, etc. is inestimable.”
As for the key reason why corporations, banks and shareholders everywhere are terrified by the prospect of “globalization” going in reverse is because as noted above, BofA calculates, it has boosted 40% of the rise in S&P500 margins over the last two decades, largely due to lower taxes from offshoring and, of course, lower compensation, i.e. wages – the biggest catalyst behind the ongoing nationalist/populist tide against the status quo.
Visually:
So why is BofA worried? Well, should trade war indeed send globalization in reverse, the most globally-oriented sectors – Tech, Energy, Industrials, Materials – could see both margins and multiples hurt in such a shift according to Subramanian.
Another risk: the pickup in capex has been led by big multinationals, which could be stymied by uncertainly around tariffs. So far, there are no signs of this – capex guidance remains above avg., and S&P companies have cited capex as their key use of tax reform proceeds.
Putting it together, what is the risk to overall EPS? Recall that last week Barclays estimated that the threat to S&P earnings was roughly an 11% drop if 10% tariffs are enacted across the board.
What about BofA? Using input cost data from the BEA, the bank estimates that a 10% increase in import costs would equate to a 3-4% hit to S&P 500 EPS (assuming foreign sales fall by ≤2%), and a ~50bp hit to operating margins.
It is worth noting that while tech is the biggest contributor to S&P earnings, not all industries might be impacted by trade wars. For example, China consumes $120bn+ of semis, these are used to produce $700bn+ in finished electronics, and given the absence of local substitutes, it is hard to argue that tariffs would have a sizable longer term impact on US chip imports. For other industries, the impact is more evident with BofA especially concerned about tariffs in an industry, like retail, with limited pricing power where production shifts could take years.
So, according to BofA, what is the worst possible outcome? Here is Subramanian’s take:
Worst outcome = stagflation: global growth would suffer despite local inflation. An IMF simulation found that if the US, China and Europe each raised import prices by 10%, GDP would drop by 2-3% in all three regions, not including second-order impacts (confidence, etc.). Tariffs + higher oil prices = “bad” inflation that could offset the consumption boost from higher wages/tax reform.
Or, to summarize, “we see stagflation as the biggest risk to equities.“
Which is ironic, because even without a “trade war” the US is already headed there, thanks to surging input costs and rising inflationary pressures, while GDP growth is set to slump going forward according to Goldman.
In other words, we are already there.
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