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An Investor's Guide to Managing Escalating Global Trade Tensions

(Bloomberg) -- Intensifying trade pressure around the world seems to have sparked a risk-off tone for global financial markets once again, forcing investors to consider where to turn should the flareup intensify into a full-scale trade war.

After weeks of looking past the rising rhetoric, markets have taken notice after President Donald Trump slapped tariffs on $50 billion worth of Chinese goods last week, and China immediately punched back. The S&P 500 was down 0.4 percent as of 11:43 a.m. in New York Monday, after falling as much as 0.8 percent, with selling heaviest in areas the two countries have targeted, like telecommunications and consumer staples.

“People are losing some patience with ‘It’s just a negotiating tactic’ reason for the tariffs because instead of leading to a formal negotiation, it is leading to an escalation,” Peter Boockvar, the chief investment officer of Bleakley Financial Group, wrote in an email to clients Monday.

Here’s where money managers say investors can find some relief:

Small-Cap Stocks

Smaller, more domestically oriented companies are generally seen as a safe haven in a global trade spat since they make most of their money at home. About 43 percent of S&P 500 sales came from abroad in 2016, according to S&P Dow Jones Indices data, compared with roughly 20 percent for the small-cap Russell 2000 Index.

“If a trade war starts, you want to allocate to those investments which are the least sensitive to global trade, and that’s small caps,” Ash Alankar, head of global asset allocation and risk management at Janus Henderson, said on Bloomberg Television.

Small-cap companies are also benefiting from the tax overhaul and a stronger dollar. The Russell 2000 has gained around 10 percent this year, more than double the return for the S&P 500.

U.S. Dollar

When it comes to currencies, the dollar may be the best place to take cover, according to Alankar. Should a full blown trade war erupt, the U.S. stands to win because there’s no full replacement for what the country provides to the rest of the world -- intellectual property, he said.

But stay away from emerging markets.

“We see strong U.S. dollar, weaker emerging market countries,” Alankar said. “If you look at who provides the most or contributes the most to the global value chain, it’s emerging markets. So emerging markets stand to be the most affected in a negative way via a trade war. But relative to the rest of the world, the U.S. should stand quite good.”

Defensive Equity Sectors

Should the spat between the U.S. and China escalate to a point where it hits global economies, traditionally defensive equity sectors such as utilities and pharmaceutical companies could provide a buffer, according to Jim Paulsen, chief investment strategist at Leuthold Group.

“They provide a dividend buffer and steady earnings growth,” he said by phone. Plus, “You’re going to buy toilet paper and toothpaste whether the economy is in a recession or whether it’s booming.”

Consumer staples are typically seen as a defensive hedge, but those shares now find themselves caught in the middle of the trade dispute since China is a major market for those exports from the U.S. After four straight months of losses, the S&P 500 Consumer Staples Sector has gained more than 3 percent so far in June. However, it’s the second worst performing group on Monday, losing 1.5 percent, and is down more than 11 percent for the year.

Middle of the Curve

As investors run from risk assets into safer investments such as Treasuries, it could further aide the flattening of the yield curve. To Doug Peebles, chief investment officer of fixed-income for AllianceBernstein, that makes the middle of the curve more attractive.

“That’s the whole notion with the flattening of the curve, why do you want to take on almost double the duration?” he said by phone. “If in 2012 you had told people I can give you 3 percent instead of 50 basis points on the five-year Treasury, they would’ve been falling over themselves to buy it. And now we’re sitting up at these levels.”

Commodities

Restrictive global commerce could slow growth around the world and also add to inflationary pressures. That, in turn, could boost commodity prices, according to Paulsen, who advises a focus on industrial commodities, energy and materials. With the Federal Reserve looking to raise interest rates and the preferred inflation gauge at its 2 percent target, investors are eyeing inflation levels.

“If you do have a full blown trade war, that’s obviously not good for growth and yet it’s also not good for inflation,” AllianceBernstein’s Peebles said. “If we have a growth slowdown, the last 10 years we’ve all been like, ‘Okay, that means we have more deflationary pressures,’ but the way that a trade problem works is that the prices don’t necessarily go down.”

©2018 Bloomberg L.P.

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