Escalating tariff threats from the U.S. and China likely will get worse before they get better, as the two countries continue ongoing attempts to resolve their trade dispute.
UBS equity analyst Jay Sole said Friday that consensus earnings per share estimates “could fall” for most of the apparel and retail companies that he covers. He also noted that the “range of potential impact is wide.”
As Sole explained, “Companies with more exposure to Chinese imports into the U.S., less pricing power and lower [earnings before interest and taxes] margins are likely to experience greater pressure on earnings than companies with the opposite characteristics.”
The analyst believes that companies such as Nike Inc., Lululemon Athletica Inc. and VF Corp. are better able to weather the storm, while retailers such as Gap Inc., Kohl’s Corp. and Macy’s Inc. are more likely to underperform.
Why?
“Department store [price/earnings] valuations look low today, but the market may be underestimating how negatively impacted their earnings might be from tariffs,” the analyst explained.
“Enough levers to pull”
Charlie O’Shea, senior credit officer at credit ratings firm Moody’s Investors Service, said, “While the negative impact of higher tariffs on retail is very real, we believe the largest, strongest retailers have enough levers to pull with vendors, sourcing diversity, and breadth of non-tariff impacted products to weather the storm with minimal disruption.”
He explained that retailers such as Walmart, Target, Costco and Amazon should be able to “significantly alleviate” any potential damage from higher tariffs because they have enough diversity in their supply chains, and have done “ample enough pre-buying” over the past several quarters.
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Fitch Ratings’ senior director David Silverman said that while some firms have been able to move production sources from China to other countries, that strategy has created a different set of issues. “This will help avoid tariffs though, in some cases, these companies could see higher manufacturing or shipping costs, and create execution risk related to new factory partners,” he explained.
Jeff Pratt, who heads up BDO’s supply chain services practice, said that companies that haven’t been able to move their supply chains outside of China could see the additional 10 percent tariff have a “material impact on their bottom line, which they may try to compensate for by raising prices to consumers.
According to Pratt, the bigger challenge might be for retailers and how to plan for “this climate of uncertainty.” Margins are already under pressure, he said, adding that if “manufacturers push through tariffs as price increases to retailers, some retailers may need to pass these increases on to consumers.”
“No winner in a trade war”
On Thursday President Trump kicked off the latest tit-for-tat when he tweeted that new tariffs on Chinese imports that haven’t been taxed before—apparel, footwear and soft textiles—will get hit with a 10 percent duty starting on Sept. 1. And while he can also decide to postpone the tariff at any time, he’s also threatened that more tariffs could be forthcoming.
The tariff on Tranche 4 goods was originally planned as a 25 percent duty starting in July, but that was put on hold on June 29 after Trump and his Chinese counterpart Xi Jinping met at the G-20 Summit in Osaka and forged a trade truce. That meeting paved the way for the two countries to restart negotiations on a trade deal. The countries were believed to be close to an agreement when talks broke down in May, with the U.S. charging that China backpedaled on promises that it made.
The two are disputing several issues, but the one that’s key for the U.S. is the protection of intellectual property assets.
China’s foreign ministry spokeswoman Hua Chunying said at a press conference Friday that Beijing would have to take countermeasures if the U.S. went ahead with its threat to impose more tariffs on Chinese imports. She said the new levy “is a serious violation of the consensus reached by the Chinese and U.S. presidents in Osaka, and runs counter to the right direction,” noting that the escalation of trade frictions does not serve either country, their citizens or the whole world.
Hua added, “China believes there is no winner in a trade war. We do not want a trade war, but we are not afraid of fighting one.”
Economic growth at risk
Presuming that Trump actually makes good on his threat and doesn’t put September’s hike on hold, the new tariffs also present risks to U.S. economic growth.
Wells Fargo Securities’ senior economist Tim Quinlan noted Friday that trade flows are slowing. He also pointed out that the trade deficit narrowed to $200 million in June. That’s not because of a change in the trade balance, but only because “imports fell more than exports, which is not a sustainable path,” the economist said.
He also said that “trade is drying up,” noting that exports are down $7 billion and imports are down $5.3 billion from 2018 highs. The high on the import side was in October 2018, when the first round of China tariffs was announced.
Moody’s Analytics economist Ryan Sweet said it wasn’t clear whether the decision to implement additional tariffs on China was a negotiating tactic or an effort to put additional pressure on the Federal Reserve to ease monetary policy further. He did note that if the additional tariffs on China were implemented, the total effective U.S. tariff rate would be 5.4 percent, up from 4.4 percent today and 1.5 percent at the end of 2017.
UBS economist Seth Carpenter believes that the new tariffs, if imposed, could take about a quarter of a point off the GDP, crimping growth slightly in the fourth quarter and weighing on growth throughout 2020. Given a slowing down in the real economy and Federal Reserve Chairman Jerome Powell’s fear of an “uncertainty shock,” he is anticipating more Fed rate cuts ahead.
“The direct effects of last year’s tariffs are fading rapidly, with solid re-acceleration in manufacturing employment and related strength in business services employment. However, there has been some spillover into the rest of the economy as total employment growth has remained soft since last year,” Carpenter said.
On Friday, U.S. data indicated that fewer nonfarm jobs were created in July than expected at 164,000 new jobs versus the 165,000 that were expected. May and June numbers were revised downward, and the current average monthly gain over a six-month period is 141,000, versus over 200,000 over the same period in 2018.
Carpenter also noted that tariffs will hurt “already delicate margins of retailers, accelerating retail outlet closures.”
The UBS economist also raised the spectre that other tariffs could be ahead on other fronts. “In recent weeks, Trump has stated that he is considering tariffs against France because of the taxes levied against U.S. digital firms. We have consistently said not to dismiss such comments as idle threats [as] Trump has proven to be serious about imposing tariffs,” Carpenter said.