Sectors Most Exposed to US - China Trade Tensions

As US trade news continues to dominate headlines and the market, we'll resume our examination of Chinese and US stocks through the lens of the Exchange Rate Sensitivity factor. This time, we'll be decomposing exposure to this factor in both countries at the sector level, to gain an understanding of what industries are most represented and to see what differences we can identify between the Chinese and US exporter/importer groups. We'll also find the companies in each country that are most exposed to Exchange Rate Sensitivity.

Let's first take a look at the past week's market and factor action:

‍US Market (5/24/19 - 5/30/19)

• The market drifted down this week before being roiled on Friday (S&P 500 down 36.8 points, not captured in above chart) by Trump's surprise announcement of higher, escalating tariffs on Mexico.
• US oil also slumped on Friday in reaction to the news, with Brent down 11% in May and natural gas at its lowest since June 2016.
• Chinese state media also telegraphed that China will hit the US with "major retaliative measures" in reaction to the blacklisting of Huawei.

Here's an update on how some key factors (and US Total Risk) have changed in the US model over the past week, using our normalized return indicator:

• Momentum continued to shoot upwards (+1.51 standard deviations over the past two weeks), and is now Extremely Overbought in our normalized return framework.
• Size appears to be finally seeing a slowdown in negative normalized return, after falling significantly over the past 6 weeks.
• Growth's upward trajectory seems to be flattening, and at 1.06 SD above the mean is now in Overbought territory.
• Profitability took a bit of a hit, continuing to suggest that Quality hasn't been a market priority.
• Volatility and Market Sensitivity continued to sell off.
• US total risk (using the Russell 3000 as proxy) stayed essentially flat this week.

‍Decomposing Exchange Rate Sensitivity at the Sector Level

‍Although tariffs with Mexico has now entered the mix, the US trade dust-up with China remains at the top of investors' minds, especially with the expectation of imminent retaliatory measures from China.

As a reminder, we've built two portfolios (one with US stocks, the other with Chinese) that are long the companies with the highest exposure to Exchange Rate Sensitivity (ERS), and short those with the highest negative exposure to the ERS factor in their respective country. Exchange Rate Sensitivity (ERS) is defined as 6 month beta to returns of currency basket containing USD, EUR, GBP, & JPY.

Let's take a look at how net sector exposure has trended in China since the Trump inauguration:

‍Chinese Exchange Rate Sensitivity Portfolio - 1/20/17 - 5/30/19

We can see that the sectors that have had the most exposure to ERS have generally trended upwards in their exposure during this time period. Comm Equipment, for instance, started around neutral, dipped into negative exposure, and then has quickly risen over the past year to become the sector with the most exposure today.

Here are the top 5 net exporter industries in China, as of 5/30/19:

Lastly, here are the top 5 companies with the highest exposure to ERS in the China portfolio:

US Exchange Rate Sensitivity Portfolio - 1/20/17 - 5/30/19

In the US, Healthcare and Specialty Retail have trended upwards in their exposure to Exchange Rate Sensitivity pretty rapidly over the past year. Also of note is that the biggest negative exposure in the US, Oil & Gas, recently hit its lowest point on May 9th at -0.10 as we continue to be a net importer.

Here are the top 5 net exporter industries in the US, as of 5/30/19:

And here are the 5 companies in the US with the highest exposure to ERS:

Conclusions

‍Using these portfolios that we built in the US and China, we've identified the sectors that have the most (and least) exposure to Exchange Rate Sensitivity. In doing so, we're now able to see the sectors that will be most impacted by future news on the trade front. We also note that in both countries and in most cases, sectors that have been net exporters have been increasing their exposure to ERS since the beginning of the Trump administration.

We'll keep an eye on these sectors as tensions between the US and China continue, as well as the current Mexico situation, to see what insights we can glean through a factor-based framework.

Regards,
Omer