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Trade Tensions Are Back: Here’s How to Deal with It

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Trade Tensions are Back

In early, stocks rallied after President Trump and Chinese President President Xi Jinping met at the G-20 summit in Japan, pledging to restart trade talks between the world’s two largest economies. Looking to assuage investors previously chastened by trade tensions, Trump noted that China pledged to boost its purchases of U.S. agricultural goods and that the two sides would negotiate in good faith going forward.

Fast-forward less than a month, and it seems those bets are off. During the final week of July, an American trade envoy headed to Shanghai for trade negotiations, but soon thereafter, Trump took to Twitter to voice his displeasure with the talks.

In example of death by 280 characters, the limit for tweets, Trump sent stocks tumbling in the final trading day of July, threatening 10 percent tariffs on an additional $300 billion worth of Chinese goods to go along with current levies of 25 percent on $250 billion of China-made products. Among other issues, the U.S. president complained China has not made good on its promise to up purchases of American farm products or stop the flow of deadly fetanyl to the U.S.

“Additionally, my friend President Xi said that he would stop the sale of Fentanyl to the United States – this never happened, and many Americans continue to die!,” said Trump in one of several tweets.

Indeed, the trade relationship between the U.S. and China is severely damaged and data confirm as much. In a report out Friday, Aug. 2, the Commerce Department said that in the first half of 2019, China was not the largest trading partner of the U.S. In fact, China slumped to third behind Mexico and Canada.

Fortunately, there are ways for advisors and investors to mitigate trade risk while remaining engaged with equities.

Check Export Exposure

In aggregate, the S&P 500 generates about 71 percent of its revenue in the U.S., but at the sector level, some groups have higher percentages of domestic sales than others. There are 11 sectors represented in the S&P 500 and just three do not have domestic sales-weighted averages of at least 60 percent – technology (41 percent), materials (53 percent) and energy (58 percent), according to S&P Dow Jones Indices.

Admittedly one week is a short time frame, but the week ending Aug. 2 paints a picture of sector sensitivity to trade wars. During that week, 27 of the 30 members of the Dow Jones Industrial Average closed lower including the Dow’s only materials components, its two energy constituents and all six of its technology residents.

As for the sectors with the highest percentages of domestic revenue, these are generally defensive groups that benefit from lower interest rates. For example, utilities generate 95 percent of their revenue in the U.S. and for the real estate sector, that figure is 84 percent, according to S&P Dow Jones.

Those wanting a bit more adventure while still maintaining a defensive posture may want to consider healthcare, a sector that depends on the U.S. for 86 percent of sales and one that currently looks attractively valued compared to other defensive sectors.

“Health care, the worst-performing sector this year, trades at 15 times forward earnings, below the 17 times multiple on the S&P 500. By comparison, staples, utilities and REITs trade closer to 20 times earnings,” reports CNBC.

Risk Doesn’t Have To Be Discarded 

Predictably, trade tensions often prompt asset allocators to dial back risk, be it at the sector level or through investment factors.

Of the three primary market cap segments – large, mid and small – small generates the largest percentage of sales on a domestic basis. As measured by the S&P SmallCap 600 Index, the percentage of domestic revenue is 78.8 percent and rises to 80.6 percent for the S&P SmallCap 600 Growth Index.

As for a growth sector with a heavy domestic focus, communication services fits the bill. On a sales-weighted basis, that group derives 97 percent of its revenue in the U.S., the highest percentage in the S&P 500, according to S&P Dow Jones.

It might be easy to attribute that massive percentage of domestic sales to cable companies and the likes of AT&T and Verizon and that is not entirely inaccurate. However, Facebook and the two classes of Google parent Alphabet stock combine for about 43 percent of the communication services sector. The average China-derived revenue percentage for those two companies was just 5.5 percent last year.

Related: The Deeper Side of ‘Investing in What You Know’

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