Investment Newsletter July 2018
Where is an iPhone made? It may seem like an odd question to ask in an investment newsletter, but at a time when investors are worrying about a trade war between the US and China it is perhaps useful to understand. Unfortunately, this apparently simple question does not have a simple answer!
Mike Deverell Investment Manager
Equilibrium Investment Management
Processor – Taiwan Gyroscope – Switzerland Accelerometer – Germany Screen – made by a US company, using factories in: Brazil Malaysia Turkey And 23 other countries…
Apple is of course an American firm, listed on the Nasdaq stock exchange and headquartered in California.
An iPhone therefore comes from multiple places, but the final assembly takes place in China.
However, an iPhone is made up of a variety of different components, most of which are not made by Apple themselves. Below is a non-exhaustive list of some of the main components and where they originate from:
The US has a massive trade deficit of around $370bn with China, something that Donald Trump keeps complaining about. However, the iPhone 7 alone accounts for $15.7bn of that deficit.
Battery – South Korea (made by Samsung) Camera – Japan (Sony)
As President, Trump is understandably keen to protect US jobs and the American economy against
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter July 2018
what he sees as unfair competition. The problem is, international trade these days looks a lot less like an export of simple commodities but more complex like the iPhone. Should you add a tariff onto an iPhone to protect US jobs? What impact might that have on Apple’s profits and its future investment in the US economy? Of course, the intention might be that Apple decides to open more factories in the US instead, something they have said they will consider. That will be good for jobs, but may not be good for consumers since an American made iPhone is likely to be more expensive than one assembled in China.
What happens next?
So far, so complicated. More important to ask is what impact this could have and what might happen next? Chart 1 comes from a recent speech by Mark Carney, the Governor of the Bank of England. This shows that a 10% increase in tariffs on trade with the US could reduce UK growth by around 2% over three years. It could reduce global growth by closer to 2.5% and US growth by almost 5%. Given this, why would Trump continue with his current trade tactics?
Of course, as the US applies tariffs on imports, so do its trading partners by applying tariffs on US exports. Again, that is far from simple. As we’ve mentioned in previous newsletters, BMW makes many of its cars in the US. Last year BMW built 385,800 vehicles in South Carolina. Of those, 87,600 were exported to China and 112,900 were sent to Europe, in both cases this is more than were sold in the US. Should the EU put tariffs on BMWs? What impact would that have on the (mainly German) manufacturers that make many of the components?
that go in the other direction, the potential impact on China could, in theory, be much greater than on the US. It therefore seems likely that they may end up making some concessions. In particular, Trump would like China to grant greater market access for US companies. At present, an American firm wanting to do business in China usually sets up a joint venture with a local firms to aid access. Perhaps in future this will not be necessary. In essence, it seems likely that all sides will eventually back down and come to some agreement that allows everybody to save face and claim victory!
Of course, China also has much to lose from a trade war. Given that Chinese exports to the US dwarf those
Chart 1: GEP losses from a 10 percentage point increase in tariffs on US trade substantial.
Source: Bank of England - “From protectionism to prosperity” – speech by Mark Carney 5 July 2018
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter July 2018
A billion+ consumers‌
Of course the reason that US companies would like to do business in China is that there are over a billion potential consumers of their products in the country. Whilst still very poor in parts, China has a large and growing middle class with consumption now accounting for 53% of the Chinese economy. By contrast, exports are only 19% of their GDP. In our portfolios we have more exposure to China as a proportion of our equity holdings than we have ever had before. Whilst trade wars are of course a risk, our funds invest significantly more into consumer stocks than in exporters. Some of our biggest holdings include Tencent and Alibaba, which offer a range of services which are essentially the Chinese equivalents of Netflix, Whatsapp and Amazon, amongst others.
China and Asia as a whole now have much more self-sustaining growth rather than relying so much on exports to the West. The growth of the Asian consumer is one investment theme that we suspect has a long way to run and is likely to be a big driver of portfolio returns over the next few years. Disclaimer: The content contained in this newsletter represents the opinions of Equilibrium Investment Management. The commentary in this newsletter in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader. Past performance is never a guide to future performance.
Both these firms are over $500bn in size, similar to the likes of Facebook. Just like US tech stocks these companies have done phenomenally well and in many ways look pretty expensive. However, they continue to grow due to their dominant position.
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter July 2018
General Economic Overview The global economy continues to do well despite concerns over trade wars. The US has been the driver of this growth, however they may be getting towards the end of the cycle. In the UK, the economy continues to be hit by uncertainty over Brexit. Despite this, interest rates may increase by 0.25% in the near future, although we don’t expect much in the way of further rises. Inflation has fallen back but remains above the Bank of England’s target.
Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class Equity Markets Markets remain nervous but have largely recovered from their dip earlier this year. Asian equities have underperformed recently given trade concerns, however we think this makes them good value in relative terms.
Score
-3
Fixed Interest We expect low but positive returns from fixed interest over the next 18 months despite the potential for interest rate increases. We continue to prefer corporate bonds to government bonds, although we do hold some index linked gilts.
-4
Commercial Property Prospects for the asset class remain mixed. We still wish to avoid London offices and much of the retail sector. However, we are more optimistic about other cities and in the industrial sector. Our selective approach limits the amount we are able to invest in property at present.
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-3 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest, property and equity. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent EIM’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser. Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.