Analysts say possible head-winds may savage sentiment, lower risk appetite

The proposed tariffs on certain Chinese imports by the Trump administration could cast a shadow on the earnings prospects of some Chinese companies, which could suppress the risk appetite of stock investors and raise market volatility, analysts said.

The financial markets may face greater headwinds than the actual economy as fears of an escalating trade war between China and the United States could substantially lower the global risk preference. So, the governments concerned should safeguard the security of the financial markets, said Cheng Shi, chief economist at ICBC International.

In the third week of March, US President Donald Trump signed a memorandum for a plan that could impose tariffs on up to $60 billion of imports from China, covering aerospace, information and communication technology, and machinery. The Chinese investment in the US could also be targeted.

"The impact on the economy could be smaller than that on the financial markets," Cheng said. "A trade war will be negative for the stock market while it will have a neutral effect on the bond market and a mixed impact on the foreign exchange market."

Both the Chinese and the US stock markets have responded with volatility since the US government announced the punitive measures against Chinese imports.

Gao Ting, head of China strategy at UBS Securities, estimated that the new tariffs may lower China's 2018 GDP growth by 0.1 percentage point and earnings growth of A-share non-financial companies by 0.6 to 1.6 percentage points this year.

Sectors that could be affected - machinery, automobiles, home appliances, electronics and computers - accounted for 15 percent of the total revenue and 10 percent of net profit of the entire A-share universe in 2016, indicating that the impact on overall earnings of A-share stocks is not significant, according to Gao.

"Although we think the rising Sino-US trade friction will have limited impact on China's economy and A-share fundamentals as a whole, market sentiment could be hurt in the near term given peaking earnings growth and considerable valuation re-rating recently," he said.

Timothy Orchard, head of equities for Asia Pacific at Fidelity International, shared the concern that an escalating trade tension between the US and China could be damaging for the markets.

"Whilst there might be a temptation to use trade barriers to redress the costs that trade imposes on certain industries in any one country, in aggregate the costs of protection typically exceed any benefit received for an individual economy," Orchard said in a note.

"Whilst the current proposals for tariffs are limited, there is a risk that this might escalate and become more damaging. It is this risk that markets have recently started to focus on," he said.

Some economists have predicted that China may respond by targeting the US industries with political influence such as agricultural, aircraft and auto sectors, and Beijing may also hit back at US investment in China.

However, they do not expect China to use the yuan's exchange rate or the sale of its holding of US treasury bonds as countermeasures as it may tantamount to shooting itself in the foot.

US economist and Nobel laureate Joseph Stiglitz told China Daily that selling US debt would not be a rational option for China as it will have a significant effect on the US dollar exchange rate and will drive down the value of the US treasury bonds.

"China would not want to increase the value of the exchange rate and it would not want to undermine the value of the bond," he told this newspaper on the sidelines of the China Development Forum in Beijing on March 24.