How To Profit From The U.S. And China Auto Tariff Talks: Buy These Automotive Stocks?

If you are like me, you’ve probably been hanging on to every bit of news that comes trickling out of Washington and Beijing recently, especially as it relates to the on-going trade talks. But many headline watchers would have turned their gaze towards Brussels too, since recent rumblings from the Oval Office concern (the possibility or not of) auto tariffs on EU manufacturers as well.

So, what should one do if they wanted to leverage the outcomes of these talks (and the ongoing headlines) for their portfolios? Well, let’s look at some potential candidates that could drive your portfolio forward in these turbulent times.

The Environment

One round of talks between the U.S. and Chinese delegations ended in Beijing last week, and another round kicks off this week in Washington. Good signs! According to early reports, the talks will also focus on China’s commitment to buy “…a substantial amount of goods and services from the United States”. A great sign! There are also reports that over $200B in tariffs on imported goods from China, which were set to rise from 10% to 25% on March 1, might be deferred for another 60 days. An excellent sign!

Add to that the fact that of late, there have been cautiously optimistic signals coming from the Whitehouse about the ongoing negotiations. And, the Chinese Vice Premier Liu He is scheduled to visit Washington later this week. And that bodes well for optimism about an equitable resolution to the trade impasse.

Potential catalysts

As a result of global macro factors, chief of which is the ongoing trade tensions between two of the world’s largest economies, China’s economy shrank the most in 2-years in 2018. And it has recorded its most dismal growth rate since 1990. Clearly the fight with the US isn’t good news. But the U.S. economy might not escape unscathed if the war drags on.

U.S. first quarter 2019 corporate profits shrank for the first time in three years – a sure sign that the positive effect of the tax breaks are waning, and the stress of tariffs are straining corporate balance sheets. But what was shocking is not the fact that there was a profit decline (negligible – at 0.8%) – but that analysts were expecting a robust growth rate of 3.3%!

China worries are definitely crimping optimism about US corporate performance. But add to that the general uncertainty about the political scene in Washington is affecting future growth outlook too. The latest economic data analysis from Refinitiv shows a decline in the US Economic Sentiment Indicator (US ESI) for 4 consecutive months – from 4.4% to 4.00%.

Bellweathers like Caterpillar, Apple, Intel and Nvidia have also blamed China for their profit warnings, and there might be others too. At least Goldman Sachs believes so! And there lies the catalyst that could bring truce to the self-destructive trade war of the worlds!

The Play

It is hoped (expected!) that both countries will see that prolonging the inevitable is likely to be a self-destructive move. The longer the tensions and uncertainty prevails, the worse things will get for the economies of both countries. And auto manufacturing might be one of the biggest casualties on both sides.

So, if indeed better sense prevails and a deal is reached later this month or early next between China and the U.S., how might you position your portfolio to take advantage of that development?

Some of the most obvious names to consider would include names in the auto part space. Among U.S. names, AutoZone, Inc. (AZO), O’Reilly Automotive, Inc. (ORLY) and Advance Auto Parts, Inc. (AAP) are market leaders amongst their peers. Adding these names to any portfolio – even today, before a resolution to trade tensions – would be a smart move. But there are Chinese names on the list too that one should consider.

I’m also considering two auto manufacturers – especially European and Japanese ones. Why not U.S. car makers? Well, I believe that if the Whitehouse decides to not impose tariffs on non-Chinese auto and part makers, then Honda Motor Co., Ltd. (HMC) and BMW could have greater torque than, say Ford (F) or General Motors (GM).

 

Clearly, some of these names have suffered in the past two quarters. But they have positive profit margins – many in the mid to high double digits. And despite the ongoing tensions, all of them have rewarded shareholders with decent (if not stellar!) Returns – both on Equity and on Assets. And almost all have eked out some form of revenue per share, albeit a bit anemic in some cases, which goes to show resilience.

Also Read: Top Auto Stocks To Buy After Midterm Elections

The one concern that I would have would be the amount of debt that some of these names carry on their balance sheets. However, the auto and parts manufacturing business is a high-capital requirement game. You have to invest in order to stay competitive. As long as these players can churn decent ROEs and ROAs, they should be good if there is trade truce shortly.

Automotive stocks are interesting investments but these MUST BUY Stocks are set to soar
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Author does not have investment in stocks discussed in this article.

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