Blog Posts — July 10, 2019

Concerned about auto tariffs? Look to Asia for diversification…

by Christoph Schon, CFA, CIPM

Building on our earlier blog on the impact of US tariffs on EU car imports, we decided to take a look at the effects on automobile manufacturers in other regions. While German carmakers suffered the most, the picture was more varied for their Japanese competitors. We found that companies with a global footprint were more likely to incur losses in a trade war than those with a more regional focus. Combined with an expected appreciation of the yen, this could provide some much-needed diversification opportunities.

As in our original study of punitive tariffs on automobile imports from the European Union in May 2019, we applied a 6% downward shock to the German DAX® index. But this time we used the 3 months leading up to Donald Trump’s decision on May 17 to estimate the pricing factor correlations and betas for the remainder of the portfolio. While the president ultimately chose to postpone the final verdict by another 6 months, we still concluded that this period would provide a reasonable approximation of the expected factor movements.

The table below shows a selection of historical and simulated country and sector returns, based on actual market movements in the second half of June 2018, and applying the proposed DAX® shock and correlations during the 3 months up to May 17, 2019, respectively.

German auto makers hit hardest, but Chinese and US firms suffer, too

Not too surprisingly, the projected average return of -8.2% for the German automobile sector was close to our previous estimate of -8%. The results for individual companies were in a relatively tight range of -7.3% to -8.5%. Their counterparts in the US and China were only slightly better off, with predicted losses of 6% each. This indicates that American car manufacturers, which had already been suffering from the hitherto steel and aluminum tariffs, would be unlikely to profit at the expense of their European competitors. It also reflects the heavy reliance of the automobile industry on cross-border flows of components and parts.

Returns of Japanese companies were more varied…

The picture was less clear-cut in Japan, where we found that the expected performance of individual car manufacturers depended on the global reach of the firm. We noted that companies with multinational operations, in particular those with plants in Europe and North America, exhibited similar losses to their international competitors, probably again due to their dependence on international supply chains. However, there was also a much wider dispersion of projected returns, with some carmakers even showing gains. The latter seemed to be the ones with a more regional focus—those that produce most or all of their cars in Asia. This resulted in an average sector loss of -2%, but with individual company returns ranging from -3.5% to +2.0%. South Korea showed a similar average, but with almost no dispersion around the mean.

…providing diversification opportunities

This particularity can provide much-needed diversification opportunities in a sector, which is dominated by multinational production processes and cross-country supply chains. Also, for non-Japanese investors, the yen has been a reliable source of risk reduction, due to its generally inverse relationship with the US stock market. Its projected appreciation against the US dollar in the recent correlation environment was 1.4%.

Historical and simulated country and sector returns

Source: Axioma Risk™