The US and China have exchanged the opening salvo on trade in what I expect to be an ongoing front of international tension (not only in trade but also for regional influence). The $50bn worth of goods initially targeted by the US, and reciprocated by China, is detail; the key is (if there will be) escalation. These US-China specific levies have not been implemented yet and both sides are in negotiation.

Recently, Warren Buffett was asked about US-China trade at the Berkshire Hathaway Annual Meeting. He said, “it’s just too big and too obvious that the benefits are huge, and the world is dependent on it in many ways for its progress.” He was sanguine, and so are we.

However, in investments it is sometimes useful to ask what if. What if trade tensions escalate and protectionism spreads? After all, the window for a compromise is narrowing and the US has lit a fire under the EU as well with its earlier steel and aluminium tariffs. Where can investors hide?

Ironically, the answer could be the US and China.

A decline in global trade would be negative, but the large domestic consumption base in the US is an internal growth engine that buffers. The chart below shows the importance of trade (or having access to external markets) by country – the bigger the blue spot, the more the country benefits from free trade. The US has a small dot because total trade (exports + imports) is only 27% of the country’s economic output, even though the dollar value is large. For comparison, China number is 37%; Australia 40%; New Zealand 53%; and UK 58%.

In an escalation, smaller trading countries will fare far worse than the US and China, and domestically focused companies in large economies, such as the US, should perform relatively better. Also, for NZ investors, the NZ dollar will likely weaken, boosting the value of offshore investments.

Currently, Milford’s Global Equity Fund is positive on US domestic companies for fundamental reasons and the tariffs announced so far have had little impact on our portfolios. But we will be watching closely, just in case.

Trading (exports + imports) as a percentage of economic output by country

Source: World Bank & OECD national accounts data, 2016.