Not all investments will weather the ‘trade tension storm’ equally, says Principal


James Welch

The hardest pill for investment markets to swallow is the increasing uncertainty in the tone of global trade discussions and the doubt it introduces into business and consumer sentiment. That’s according to new commentary from Principal Global Investors.

Speaking about commercial real estate, Senior Managing Director of Global Research and Strategy at Principal Real Estate Investors, Indraneel Karlekar said: “Commercial real estate has defensive characteristics that may help shield investors from volatility in times of uncertainty. Since 1980, U.S. real estate has been negatively correlated to U.S. bonds and only modestly correlated to U.S. stocks and this means real estate can help add diversification to a portfolio during periods of market volatility. Plus, the volatility of real estate total returns since 1978 been about half of that in equities and fixed income. Real estate is also a good source of current income, which generally hasn’t been affected by volatility. Having a nice, stable set of income returns can give investors a further degree of insulation.”

Seema Shah, Global Investment Strategist at Principal Global Investors said that investment strategies should be reviewed in anticipation of a volatile market reaction to the Trump administration’s moves to change a global regime that’s been essentially stable for decades:  “We think the types of assets that could benefit from insulation against trade tension are U.S. small-cap stocks, municipal bonds, and commercial real estate. As the situation currently stands, the U.S. economy is relatively well insulated from trade escalations.”

Commenting on U.S. small-cap equities was Phil Nordhus, Portfolio Manager, Principal Global Equities, who said, “We believe U.S. small-caps offer some cover from the direct trade tensions. Compared to a large-cap company, the average small-cap company has half the exposure to non-U.S. markets that could be a potential sources of trade tensions, tariffs, or quotas. For U.S. small-caps, this also means that around 80% of their revenues come from U.S. customers, which may help them weather any global trade fluctuations.”

“U.S. small-cap companies are also somewhat insulated from the broader effects of escalating trade tensions because of their business models. Small-cap companies tend towards domestic supply networks, which limits the exposure to inputs subject to tariffs.  Further, the recent U.S. tax break on repatriation of foreign earnings won’t have much impact on small-caps, but the lower rates and other changes will mean that small-cap companies are getting a bigger bang for their buck.”

James Welch, Portfolio Manager, Principal Global Fixed Income advocates for Municipal Bonds as  a safe haven in times of uncertainty. “Munis are fixed income securities issued by state or local municipalities and they can help add diversification to a portfolio because of their lack of correlation with other types of assets. Right now, we’re seeing the lowest volatility in benchmark muni yields since 2010.  These bonds are tied to domestic demand: assets like utilities, toll bridges, hospitals, and highways and don’t depend on imports or exports.

“However tariffs and quotas can start affecting state and local governments. If there’s a tariff on soybeans, and your state exports soybeans to China, then eventually you’ll start to see some effects through lower tax revenues. The effects on munis would then tend to lag other asset classes.”

Read the full Principal Global Perspectives paper here.

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