Stephen Byrd : Okay. Good morning. Good afternoon. Good evening everyone. Thank you so much for being with us here today. We're here today to talk about the impact of tariffs to equity markets and to equities. I must remember I'm head of product for the Americas and head of sustainability research. Joining me on co-hosting today will be Mark Vander Plume. Mark is on our specialist sales team focused on industrials and materials.
And also Brenda diverse Brenda is a sustainability analyst. Your morning salon. So thank you so much. We have many analysts from around the world on this webcast today.
quite a bit of potential impact, some potentially negative some actually quite positive.
And we really walk through, the dynamics that we do appreciate. We're in a very fluid period of time. We're going to walk through that fluidity that is, of course, very important. But we want to try to give investors a framework so that you can really understand what might the impacts be. Had a position, especially in light of the the near-term pause that we have, in terms of a couple of the key, tariff regimes, so that we hope that that that is helpful.
And, I think, all of you all very, very well know that over this past weekend, President Trump and his administration imposed tariffs on imports from Canada, Mexico and China. We have a fact sheet describing that. And President Trump stated that until the, the crisis, and
dynamics that he mentioned as alleviated, he was going to be implementing, a number of tariffs, he did suspend those tariffs, temporarily, with respect to Canada, Mexico.
But of course, we need to be thinking about those tariffs when and if they do come into place. And of course we need to think about China tariffs quite carefully. So you see on the note links to many other notes. And our teams around the world have a very comprehensive seven analyzes to really understand what all the impacts might be.
So we do hope that that's helpful on the zoom is is quite a star studded list of our best analysts around the world, focusing not just at the sector level, but also at the macro level. And, so we are really going to try to touch on, all of the key dynamics that that really matter. I'm going to start really more on the macro side of things.
And I want to start with, Ariana Salvador. Ariana Salvador is our policy analyst early on, has done some really excellent work thinking through, the tariff regime, thinking through a framework to, to understand, how these may really play out. Sorry. Yeah. Thanks for being with us. And I wondered if we could just go ahead and kick off the webcast with, some of your thoughts on, from the policy perspective, how are you thinking through the tariffs?
Obviously, we saw what was announced. Well, we also saw, the tariffs were delayed in the case of, Canada, Mexico. So can you just talk through your views on the events that transpired, how to think about the key aspects that investors should be thinking about right now?
Ariana Salvatore: Yeah. Thanks, Stephen. And I think that you said it was the word of the day, which is fluidity.
That's that's kind of the big theme we keep coming back to. We obviously got website back and forth, you know, across a few headlines over the past few days. But we in a way, ended up kind of back where we started. So that is to say, our base case of fast announcements for implementation on tariffs held up.
So we didn't think that the tariffs on Mexico and Canada were going to be avoided, and that Trump would go ahead with the tariffs on China early in his term. And the reason we thought that was because Mexico and Canada have a much lower bar to clear when it comes to policy concessions than China does. So when we think about that, what Mexico and Canada had to offer, it presents Trump with maybe an easier, kind of quicker policy win than the Chinese government could have given him.
So that's why we think those tariffs on China are a bit stickier. But just to take a step back and explain how we're thinking about the administration strategy, tariffs really accomplish two distinct goals. So the first is as a negotiation tactic, a tool of leverage. Now the administration's been very transparent about this aim. And the second objective is really as a means to reduce the trade deficit or address a longer term structural dependency.
Right. So this we kind of categorize as a strategic de-risking. So when it comes to Mexico and Canada, we think there's significant low hanging fruit from a policy perspective. You know, immigration for example. And we think that Trump can pretty easily leverage tariffs to extract concessions on those politically popular salient issues. And that's kind of what Trump and his top advisors had been telegraphing in the lead up to the tariff imposition.
Right. We heard from Rubio last night because not yet confirmed, but his likely, secretary of Commerce secretary Busan. And they've all advocated for this approach to tariffs that leverages them in some way to get our trading partners to give us some sort of policy concession. Now, when we think about China, it's more of a strategic de-risking. That's, in our view, driven by national security and economic concerns.
And so we think in that relationship there's a much higher bar to clear for avoidance or delay of the tariffs. Specifically, when you think about what the US and China have to compromise on, there's some real sticking points, right? It's a much tougher nut to crack. They need to address the noncompliance of the phase four, phase one deal for the past four years.
There needs to be some sort of mechanism to account for the commodity purchases. So it's a much more difficult process. And, and a higher, you know, higher bar declare a much, much more complicated negotiation. So that's why we think those tariffs will stay on and increase gradually over the balance of this year and next as well.
Well, it's a great way to start. I mean the dynamics between Canada Mexico and the US. Do strike, strike me as very different. And you laid that out really well, a much higher bar when it comes to China. Many more strategic implications there. So that makes sense. And, Arianna laid out, three different paths, to think about in terms of outcomes on tariffs.
You just talked through those paths a bit. So so the first is tariffs are voided. You know, you have a quick resolution or they're delayed. So this is exactly what we saw with Mexico and Canada. We saw 11th hour negotiations, some discussions between Trump and these other leaders. And we think that really kind of punch out the tariff risks.
And brings us back to this, economic and strategy baseline that we had pre this announcement, right the second is more of a limited or temporary tariff. So in that case you would see tariffs imposed. But if they're imposed to the full extent only for a very short period of time or a significant carve outs. Trump kind of hinted at this with the exemptions around Canadian energy imports.
So we think in this case you would see much more of a muted impact to the economy and to markets probably going to be concentrated in a few key sectors that are subject to these tariffs. But in the third scenario, you would see the tariffs broad based and durable, which is not exactly what our base case is.
We think we're kind of somewhere in between sections two and three for, for China. But let's say you see these tariffs actually implemented for something like 30 days or more China tariffs scaling up quickly. And we have high conviction that they're going to stay in place for a long time. Like I said, that's not our base case.
But we think that currently markets are not fully price for this outcome at all. So the last thing I'll say between these three different paths is we can move very quickly, kind of between these scenarios. And back to the point at the top of my remarks around fluidity, a lot of this comes to the president's control and the president's discretion.
So he can kind of decide which of these paths we're going to go on. So that's why it's really important, in our view, to think about this from a scenario perspective and think through all these different paths, just because we can't exactly stay married to any one in particular. Yes, but it's a great point, especially at this point, that so many unknowns, it's good to at least have that framework to understand the outcomes.
That's probably a good transition. Over to economics. We have Jacob from Morgan Stanley Economics. And Jacob, you've done a lot of work thinking through the various economic impacts of tariffs on the US economy and also on the fed. And I wonder if you could just start on the US economy and just talk through the potential economic implications of the tariffs.
Again, appreciate we're in a very fluid situation. It's a little hard to predict exactly. But could you just talk maybe first on on the economy. Then we'll talk about, you know, talk about inflation, talk about the fed as well. Yeah.
Diago Anzoategui : Thank you, Steve, and thank you for the invitation to hear this. Great. So yeah. So tariffs can be if they are broad base and they are high and can be disruptive and they can have a meaningful effect in the economy.
The third scenario would be the one change in our baseline views then the most of course, if we have these, if we end up having these 25% tariffs on Mexico and Canada, then that that changes meaningfully our our outlook for inflation and for economic activity. Right. And we we released after the the announcement and note, just with some rough calculations.
So in terms of the impact on inflation and economic activity and they are meaningful, right? So this 25% on Mexico and Canada, if we add that to our baseline, that would imply an increase in around 30 or 50 basis points in inflation. So we're currently tracking 2.5 on inflation core PC for for 2025. That would mean a 3% inflation.
I mean if we had that that effect, and the effect on prices happens relatively fast within six months of the implementation, we have that level shift in price at that. That happens typically after this. And the impact is not only on inflation. Typically clients discuss on those about inflation, but something that people perhaps discuss less is the impact on economic activity.
That is, you know, other shock to final good prices, but also to intermediate goods and capital goods that are used for production. So it is natural to expect a slowdown in economic activity. And, our calculations point to it to real GDP growth of about 770 beats to 110 Bips. These are meaningful numbers. Right. So and this comes with a delay is different from inflation comes with a rate of 3 or 3 quarters.
Right. So the impact on economic activity. But that means that instead of looking at a 2% growth in 2025, our current forecast, we might have a 1.5 or even below growth, real growth, in, in in 2025. And also another hit in 26. Because again, there is a delay from implementation to the effect on economic activity. And note of course, that I give you I'm giving you ranges of estimates.
Right. And this is simply because there is a lot of uncertainty in terms of, you know, the size of the different mechanisms that can affect economic activity or inflation. Right? The final effect, you know, depends, for instance, on effects, appreciation, how much they don't appreciate, which actually tends to reduce the inflationary impact, in the economy.
And a big question mark is what would happen with corporate confidence. Right. So this this because this trade body and uncertainty, this back and forth with tariffs on and off, that's already has an impact on on economic activity. And that channel is it's such it's hard to measure. Yeah. You know you're highlighting some really good uncertainties. And also your point about you know the lag effect and also the exchange rate effect is is a.
So both really good points. And Jacob, when you think about potential impacts on the fed, how do you how do you sort of frame that. Yeah. So we actually already changed our federal. Right. Based on these announcements and this trade policy and trade policy uncertainty, because the uncertainty around trade policy came more aggressively and sooner than we we were expecting.
Right. So, we we actually took out the, the that we had in March. Right. And we only have one cut in 2025 in June. Right. And this is entirely based on our inflation forecast. So we we are assuming that tariffs on China that are going to come mostly in the second half of the year. Right. And that is are going to be mostly in China.
That's our baseline. We don't have data from Canada and Mexico. And our baseline you and and that allows the pressure to come down in the first half of the year. And that allows the fed to cut in June. Right? Of course. If we have this scenario in which the 25% tariffs on China and Mexico happen, and they say we are going to be forced to take out that gut that June cut and leave.
They have leave the fed without any cuts in 2025. I and the fed resuming cuts in, June 2026 once the negative effect on economic activity from tariffs starts to kick in and the fed then starts cutting because of slowdown in economic activity. Very good. Thank you so much Diego. So I want to shift from economics over to equity strategy.
And I'm going to first start out in the US. And then we're going to move over to to Asia Pacific. And we've Andrew, from US equity strategy. And Andrew, you've done some really interesting writing to, to talk about the, user positioning, given, where, we may see these, these tariffs land, how to think about sort of risk reward in this kind of uncertain environment.
Would you mind just walking through from a US equity strategy point of view, how do you think about this?
Andrew Pauker: Yeah, definitely. Thanks, Stephen. So, you know, we think continue tariff uncertainty really strengthens the investment case for a view that we've had for a while, which is to favor services industries over discretionary goods on a on a relative basis.
Specifically, we like financial software media and entertainment and consumer services, earnings revisions, pricing power, tech diffusion tailwinds are all stronger for services industries. And then at the same time, you know, we see tariff uncertainty as a valuation overhang for the discretionary good space. Within goods centric areas, the market with tariff exposure, we think industries with stronger pricing power, so multi industry and capital goods in particular are better positioned to manage potential, tariffs on a relative basis.
For reference, the main industries that are talking about tariffs, related to China and corporate transcripts are capital goods tech hardware consumer discretionary goods and pharma and biotech. That's for China. For Mexico. They're capital goods, materials, health care equipment and tech hardware. And for Canada, their capital goods, materials, healthcare equipment and services and energy. So a good amount of overlap between those regions, I think, you know, those those industries definitely touch on the points you made at the onset.
Stephen, as we look across the market cap of the S&P, I mean, the most significant, sort of market cap weights and kind of go down the list. The most tariff sensitive industry groups represent under 30% of total market cap. And then potential exposure is kind of highly idiosyncratic even within those groups, as are potential offsets from, you know, pricing, power supply chain, decision making, etc..
So we think that reinforces the idea that tariff risk is likely more relevant from a rotational standpoint than from a beta standpoint. I think data impact would be more relevant if we were to see tariff implementation across Mexico, Canada and China for an extended period of time. That kind of meaningfully affects, corporate and also confidence to Diego's points before and as of now, you know, that's not in the markets baseline.
One other point that I would flag, should tariffs end up going on Mexico and or Canada after this delay, one consideration for upcoming earnings results that, there's been much more discussion from corporates around China's supply chain exposure than Mexico or Canada. We showed this in our note this week, despite the fact that imports from Mexico and Canada are significant at about 30% of, total US imports cumulatively.
So the implication there is that stock specific tariff impacts associated, with Mexico and Canada may not be in the price to the to the same extent. Should we end up seeing tariffs implemented there at the end of the day? So something to keep in mind for stocks within the industries that I mentioned, particularly around earnings results over the next couple of quarters?
Should should that, policy development play out. That's really helpful. I mean, the, the idiosyncratic nature you mentioned, the more concentrated impact you mentioned. Really good points. And then on the point about Canada, Mexico, the fact the market has simply priced in. That's an interesting dynamic given, you know, Arianna, sort of framework, you know, describes potentially a constructive path with Canada, Mexico, but a lot of uncertainty.
So we could see a lot of, volatility to the extent that, that those paths are less than, than straightforward, which is certainly possible. So that's certainly framing. Thank you. Let's go to Asia-Pacific, with Daniel. Dan, you put out a fantastic note that describes the stock risks and opportunities across Asia and emerging markets. And could you just talk us through how you think about the risks and opportunities, given this tariff dynamic that we have?
Daniel Blake: So yes, there are some similarities with that, what we're hearing from Andrew, but it is more of an acute macro sensitivity. We have, in, in Asia. For example, when we look across the nation, we've got 10% of total revenues coming from the US.
The majority of those do come as exports into the US. So when we look at unpack that relative to Japan, for example, that has the majority of its U.S revenues generated onshore. So more of a diversification for Japan. And actually some stocks that might benefit from that are is coming up. So when we look at at atrium it's really hitting enter a stronger U.S. dollar, tighter financial conditions.
We've just taken out one of the rate cuts. We are expecting for this year. So that's all playing to, headwinds for local currency earnings. So if you think back to 2018, 19, there are some key similarities, when within China, tariffs coming up, much more sustained focus in the base case and in that trade tension, three and four year margins in aggregate coming down by about 70 basis points.
So we end up losing about, about 15% of earnings, through that adjustment. So if we're thinking about this, this cycle here, we might see a similar impact. So, we're thinking, 7 to 10% impact on earnings, particularly if we do this in Canada. In Mexico it would probably be, higher than that again. So even in the base case for China, we're well below consensus.
And that is factoring in, this, this escalation, if we're around, looking ahead, we do think the risks we need to flag, relative to what's in the price, you know, to address point here, China tariffs, basically expected I think a lot of the market was calling the but to some degree on the Mexican tariffs.
But we need to watch that fluid situation. But, but if we start to get into an escalatory cycle again, I don't think that's, that's the consensus from our discussions with clients. And the reactions were saying so far. So we have seen Trump talking about tariffs on essential goods, including semiconductors, pharmaceuticals, steel, aluminum, copper, as well into vessel tariffs, of course.
So if we get into that environment then looking at that further earnings, have we deriving. So we would we would caution that if Canada and Mexico come in we could see that plus downside risk to em. But if we go into a full fledged trade, potentially globally, would be looking more that because the E.M., which is down 30% from yes, there is still significant risk in in a tariff escalation.
Coming back to the at this point on growth, but ultimately through the dollar and supply chain tax. So where do we what do we stand? We think it's worth being, defensive at this point. We think position for, companies in a similar vein to, to enter the US looking for domestic demand driven, opportunities, looking at services, financials, and more of the, staples and utilities, telcos, that are just immune from this, this physicality and key risk to margins.
That means we're also underweight on semiconductors and tech hardware. That would be the worst thing on the currency I adoption that the Catholics been things too. Very bullish. But when we think about the whole posited non sensitive that is is likely to see some some impact with volumes coming under pressure in a downslope that we see the commodity semis expectations also pretty quiet and more risk in the valuations there.
So overall we think there's another way of looking at this, which is looking at specifically companies and putting a basket together of tariff exposed companies, which will continue and exhibit 40 that night at the top, during the end of the put together a great, reference point there. So I think that 4030 stocks, the whole up low to medium pricing power, which is going to be important.
And then on the flip side, you mentioned the opportunity. So we agree we're looking for stocks that can, reposition the business or enable a strengthening of supply chains and domestication. So those supply chain diversification beneficiaries, we put them in exhibit 45 46 stocks. They're all right. And we see them having positive leverage to that theme of adjusting supply chains.
I've already seen 27 points of about performance, percentage points about performance. And it's come back a little bit in the past couple of months. So we don't think that this is overbought or too expensive as a theme. So I could point it to being a hedge there across portfolio that that's great Daniel. And I mean those numbers are very noticeably large.
And up to your point though, that these are many of these impacts are expected, but the impacts could get could get worse than expected. And along with, Nick lapping, you recently upgraded Mexico equities equal weight. But you're, you're still cautious on China. And you just talked to Nicholas. You're thinking about here. Yeah. So for Mexico we we do think a lot of this adjustment was, was was more about positioning for concessions on immigration, counternarcotics.
We saw, signs that the Mexican government was actually preparing for that. And so, while we haven't seen a full stay of execution in terms of the tariffs, we have seen the light bottom up. And we're optimistic that a deal can be struck ultimately. So for now, we think actually the velocity writing was seen in Mexico as a lot of that, risk in the plants.
So grab the slide next issue. So next give us an equal weight which has been a risk. But but it's is is one to watch for that deal coming through which one is much more complex. So how are we gonna probably focus on this being that more strategic, tender Mexican, maybe stalking horses for the tariffs and the pressure that's coming up on China.
So instead of concessions from China, which we saw from Canada and Mexico, we saw retaliation and we saw signs that, China was wanting to, to, to make it to market. It can also, tighten supply chains. So looking ahead, the catalyst for watch, is all those investigations that Harry mentions, command of the Americas, this trade policy, due to report back for the first in April.
And so we'll come out at the NPC in March. We also think the policy stimulus out of the NPC will disappoint. Our economists are looking for that. So between that and then first in April we get this reviews come back, take a lot of leverage here. We think we're still in an escalatory phase, which historically is going to be writing, for Chinese equities.
And we, we, we are sitting far from distressed levels on valuations. So the question on China, would like to see if we can see a grinding grand bargain being struck. But there's a lot of this in that equation. And we think in the meantime the risk is towards an escalatory cycle for, the trade tensions going to the any negotiations in the second quarter.
That's a great thing. And thank you so much. Okay. So we're going to shift from, the macro over to really going into sectors more specifically. And I'm going to hand this over to Brenda, to kick it off and start on tech.
Brenda Duverce: Yeah, sure. Steven. Thanks. As Steven mentioned, let's start with, some of the implications that we're seeing across sectors, particularly in the tech hardware and equipment space.
This is one of the sectors we see most at risk with increased tariffs, especially given we haven't seen any concessions from China just yet. And so the China 10% increase tear products and equipment have been implemented. So Eric starting with you on it hardware. Maybe let's start at a high level. So a significant portion of the tech supply chain involves production and manufacturing in China.
But despite efforts throughout the year to diversify supply chain and into other parts of Asia and around the world, you know, we still see some risk and exposure within your space. Can you walk us through how your space evolved over the years? And then we talk through some of the exposure impact you're seeing within your sector?
Erik Woodring: Sure. Thank you, Brenda. So so let's maybe start with two overarching views. One is that, as long as this industry has existed, Asia has been the epicenter for tech hardware manufacturing. It's where there is low cost labor, a lot of skilled tooling expertise. Again, a lot of this has been focused in and around China.
And the second point being, this is all basically done by contract manufacturers. The large majority of smartphones, PCs, servers, the big end markets within tech hardware, are primarily, manufactured by outsourced third party contract manufacturers, again, many of which are based in Taiwan and China. You know, if we rewind back to the original, the first Trump administration, that is really what we started to see my universe kind of incrementally shift production out of China.
And I'm talking about assembly, not necessarily the component universe. Malaysia, Vietnam, India, Thailand, other areas of Southeast Asia with with a bit of Mexico mixed into that, maybe a little bit of Brazil or where we've seen some of, some of that production shift. But I would say for these very big markets on the, on the margin, the shift has been relatively slow.
So through kind of 21, 20, 22 period, you know, 80% of laptops still assembled in China, 78% of smartphones still assembled in China, 50% of speakers and headsets still assembled in China. So China remains the epicenter, by all means. It's just on the margin. We we have seen, we have seen a slight shift, that that shift probably can't happen, quite frankly, fast enough, just given, the fluidity, like, like Arianna talked about, and really the tit for tat that, that equity strategy was just talking about really comfort coming from the side of China as opposed to what we're seeing, the reaction from Mexico and Canada.
Yeah. No, that makes a lot of sense. So I guess this I think you lay out the overview of, you know, kind of the dynamics we're seeing within the region. Is there anything that, you know, names within your coverage can do to better mitigate the risks surrounding tariffs? Right. So let's just start very high level again. And you know, a 10% tariff on average is about a two and a half point headwind to EPS for my group on average.
Assuming no mitigation efforts, no exclusions, exemptions, anything to avoid, anything to avoid these tariffs. You know, there are really four things that my companies can do, which is one got exemptions. We saw that in the first, Trump regime. It's unclear exactly to me how this works because, these tariffs are done under the EPA as opposed to section 301 of the 1974 Trade Act.
And so a bit of a question mark there, but that is always a way that my companies can get out of the get out of these, get out of these headwinds. Second is just repositioning your supply chain. In some cases, you might be able to take in 99% assembled, product shipping to a third party country.
You can also leverage non-Chinese, facilities.
Ultimately, if all of those fail, the answer really is going to be my companies are going to raise prices, a 10% tariff, not terrible. In generally speaking, that that equates to about a 3 to 4% price hike. If you amortize that over a handful of years, it's, you know, an extra dollar per month. So it's it's not terrible.
But again, if we see a retaliation and an escalation and we get into 25, 50, 60% tariffs, that gets to a point where pricing increases, become very harmful to demand. Yeah. An incremental dollar amounts. It's not the worst thing ever. You know, for the consumer perspective, still pretty terrifying. This is a great transition to media space because I think over, the back half of the 20 tens, you seen, you know, many of the optical networking equipment attempt to diversify away from their supply chains to better reduce impacts of tariffs.
Maybe can you walk us through, at a high level, your latest thinking within your space and, and maybe even provide us the context of what you've seen happen, during Trump 1.1, 1.0 and maybe how other, sectors can learn from what your space that's done.
Meta Marshall: Yeah. So kind of similar to Eric. Our space, you know, relies heavily on contract manufacturers on the optical side of the universe that was very heavily concentrated in China.
A lot of very detailed kind of assembly. The most aggressive moves, during Trump 1.0 were to kind of move a lot of that production to further into Southeast Asia, a lot within Malaysia, a lot within Thailand, and even China based vendors have also moved their supply chains there, in part just because of cost of assembly and so on the optical side, we actually think that they're kind of in the best position today because they've already taken some of the actions or the most aggressive kind of moving capacity out of China over the last couple six years, whereas the rest of the space that's kind of less directly involved in their assembly are
uses contract manufacturers. That universe has diversified. You know, they use contract manufacturers who have diversified both because of Trump 1.0 and also just because of the supply chain challenges we saw during Covid of wanting to have kind of a more diversified chain. And so it likely will take some time to kind of move capacity out.
But the view is, okay, give it three, six months. We can probably move some of that capacity to other locations or figure out kind of based on where that end product needs to go, where it needs to be produced.
Yeah. No, that that's really helpful context. And maybe it's a really good segue into Joe's space, the semiconductor, sector. I think there's been a lot of, I guess, confusion in terms of how these potential terrorists may impact the semiconductor industry.
And so I was wondering, Joe, maybe at a high level, you can walk us through, how should we think about tariffs on China, and what it might mean for the semiconductor industry moving forward. And then, we can talk to some of the other implications that we're hearing.
Joe Moore: Yeah. Thank you. Brenda. And hi, everyone. So it's fairly unusual to actually put tariffs on semiconductors because it does a lot of damage to the, OEM and ODM buyers of semiconductor products that are in the US.
It tends to be somewhat punitive. So if you go back to Trump one, there was very little direct tariff activity. And I think we would take our lead from what Eric and me too just said. Those are the disruptive impacts. You know, the disruption on the end demand inflation of and demand, potential pull forward
Trump has described that as, you know, motivation to manufacture semiconductors in the U.S, that the Chips act, which was the subsidization mechanism, was unable to fully, realize, you know, I don't know if that's going to happen or not.
If it does happen, it would be highly negative to US semiconductor companies, for sure.
I would think that the most likely way that you would implement something like that is to stagger it over a four year window or something, because there's really not a lot you can do about it right now to think that it would incent manufacturing in the US.
It's just not capacity or capability in the US to do that. But if you stage it over time, it would prove incentive.
So we'll have to see how that goes. It's something that, may be proposed.
And again, I think the immediate impact would be negative. It would be most negative for the digital companies that have kind of mid-level margins.
I think in general, you know, we're thinking that's still an outlier case, that we have something direct like that,
And I think the main way we're viewing it is we're listening to Eric and Meta taking their lead for the impact that it may have. But thinking about these corner cases that may evolve, if there's additional tariffs coming in. So that's helpful context, I think getting some question on export controls I know not necessarily tariffs related, but still semi related to the geopolitical landscape.
I was wondering if you just could quickly touch on it on at a high level, maybe some of your latest thinking there and half forward. Yeah. So export controls have been a major factor.
And then certainly it's something that, the government is going to try to impose further restrictions were already quite restrictive. And I think, you know, it's a very difficult thing to actually achieve, to sort of take the fact that you have dominant hardware companies in AI and make sure that that means that AI development and data centers all happen in the Western world, and it gets very difficult to actually affect that.
But but I think the government is going to try, you know, and so I think you're going to see quite a bit of, potential disruption on that side. And again, that's something that that actually over eight years we've had as a fairly consistent concern. Biden's stylistic biases of how he implemented it was quite a bit different than Trump.
But export controls are a major factor for us, across the board and will continue to be principally, I think, equipment and, and AI is going to be the biggest impact there.
Switching gears a bit, going to the retail sector, this is another area in which we see increased tariffs. Could potentially be, you know, detrimental within the space. We have chat here from our, soft lines team chat at a high level. Can you walk us through how you all are thinking about tariff implications within your sector?
And, and are there any unique efforts within your space, company you're seeing companies take to mitigate these tariffs with, tariff risk?
Chad Britnell: Yeah, sure. Thank you. Brenda. So high level, our space is meaningfully more exposed to China from a sourcing perspective than Mexico and Canada. Put this in perspective for the group. China accounts for 21% of U.S. apparel imports, while Mexico and Canada only account for 3% 1%, respectively.
So with that backdrop in mind, the incremental 10% China tariffs are most impactful to the earnings power of our coverage. Whereas the 25% Mexico and Canada tariffs are much less meaningful. I'll elaborate on the China piece a bit more. So with the incremental 10% tariff on China goods, we now see 20% average downside to consensus 2025 EPS estimates across our soft lines coverage.
Our companies have talked about mitigation strategies that I can dive into, a bit more, but high level, you know, we think these mitigation efforts could prove limited in scope, and they will be more viable for select companies within our coverage rather than, across the entire group. So this set up that includes EPS pressure and more limited mitigation abilities, in our view, if further emboldens our view from from our outlook that profitability improvement across our coverage will be hard to come by this year and will be mostly tied to to sales growth, acceleration, associated fixed cost leverage and then expense reduction rather than more meaningful improvement and gross margin
like we've seen, in 2024. So that's China tariffs. Then to quickly touch on Mexico and Canada, the headline here is that sourcing exposure across our coverage is low. And incremental tariffs will be much less impactful than China if implemented. The caveat to that is that while sourcing is low, this does not necessarily account for product that is routed through Mexico and Canada distribution centers into the US, which would be subject to tariffs according to our public policy team.
But it is unclear which DCS are serving their domestic markets and which are being routed to the U.S. Early conversations with our companies suggest it's been a bit of a mixed bag.
So the aggregate impact to our stocks, as it pertains to the distribution center exposure in Mexico and Canada is harder to pin down at this stage. In terms of, mitigation, strategies. I mean, over the last 12 months, our, our companies have mostly pointed to a similar playbook as Trump. 1.0. The key strategies they've talked about include diversifying, sourcing away from China, taking price, reducing AUC, and sharing the incremental cost of tariffs with vendors.
So to answer your question simply, there's nothing necessarily unique by company to point to within our coverage. As I mentioned earlier, you know, we think these strategies may prove limited in scope, mainly because our coverage has already pursued meaningful China diversification over the last five years. The apparel category has limited to to no pricing power.
It's historically a deflationary category. A lot of the AC work I mentioned, and that the companies have spoke to as a potential mitigate has already been done, mainly as a result of the pandemic and supply chain disruption. And then lastly, gross margins probably sit at highs across our space. So there's there's limited room there as well.
With that all in mind, we do think there are certain stocks that have, better positioning than others as it pertains to mitigating tariff impacts. In 2025. And I can get into a few of those if if there's time. Thanks for that chat. I think the overview, is really helpful context. Let's pass it to Mark to go through the autos and industrial space.
Mark Van Der Pluym: Great. Thanks, Brenda, and good morning. Good afternoon and good evening, everyone. Yeah. So autos obviously front and center in the tariff debate, especially as we think about Mexico and Canada respecting that, you know, parts and half finished vehicles sometimes cross the northern and southern borders a number of times before a final, final completion. But maybe, Adam, kick us off on how you think some of your auto industry players can mitigate some of these tariff risks. And how are you framing that right now?
Adam Jonas: This is not an industry, that that's good at mitigating these types of risks, frankly. Mark, a 25% tariff on 25% of, of, U.S. auto sales that sourced from Canada and Mexico. About 2.7 million vehicles out of the 16 million are in Mexico, an extra million from your home country up north?
It's pretty devastating. It would add about $3,000 to the price of car. I think it would bring our 15 million units, our bear case into play. If we lose a million units, that's, you know, 50 million of lost revenues and 15 billion lost operating profit. You know, I think you can look at you can comfortably look at decrements of $15,000 a vehicle, and you're going to say, well, why don't we increase prices?
The problem with increasing prices is that the starting point is an all time high affordability on, sorry, all time high on affordability. The average monthly, payment seven $2,730, adding, you know, 4 or 5% to the price of a car would take that just shy of 800 bucks a month. Then if you added just even 100 basis points of interest rates on that, going beyond $800 a month.
Consumer is not going to be happy. So, that is not something that we think is going to really play out. Like, would they really have 25% tariffs on for a full year. Unlikely, very, very unlikely. So I'm thinking exemptions, loopholes, carve outs, that kind of stuff the way we began. And I think autos are very, very front and center for that.
You know, it's interesting the difference between Trump 1.0 and Trump 2.0 is Trump 1.0.
People weren't talking about AI. Now electric vehicles or the socket for the AI brain. So if we're going to encourage offshoring, which is something I know Chris is going to talk about, we're not going to onshore internal combustion here. We're going to onshore, you know, autonomous and electric technology,
I think the strategic elements of, of of this kind of tariff, regime is something that also, again, could further weaken, the, the, the local industrial supply base. So I'll kind of pause there and we can move around. Yeah. I guess just as a follow up to that, I mean, given how ingrained the supply chain is right now spanning China through Mexico and Canada, your sense is simply that there is no workaround at this point in time.
And either the OE eats it or it gets passed through the consumer. Ultimately. Yeah. Or it just doesn't happen.
But like it's one of the scenarios, right. It doesn't happen. So again there's there's there's unanimity across the suppliers and the OEMs that they're all going to have to have some joint sacrifice or kind of ease.
So the only real resolution is that they all share it, and then the consumer ultimately pay a higher price. Maybe if I stretch it, the dealers have been flying this year because they're seen as a little more protected because there's no Chinese imports. And maybe that might be supportive for used car prices. So and some of the kind of the Manheim underpinning, which is good for the used car market.
Right. Well, I guess maybe that's a good segue over to Tim, where it's tougher to call the bluff right now, given what the administration has already announced. But as you're kind of seeing, you know, the Greater China auto parts industry right now, where do you think investors should focus their attention, and where do you think there's still incremental risk or even perhaps opportunity?
Tim Hsaio: Thanks, Mark. So last year, China exported to the US and 2 billion to Mexico, which I think a of that has to be redirected to the US. So these trade accounted for around 15% of China's auto related exports in aggregate. So I think the recent volatility of China auto sector is apparently highly correlated with trade with.
So but although tariff situation like I say disrupted by probably also partially related to what having just mentioned, we think it with automotive the urge get carmakers, the component makers to refocus like some new technology with holistic growth opportunities. So if you think about what happened, the state EV that accounted for more than 50% of new car sales in China.
So to stand out of the pack, I think a supply chain parts maker with the increasingly focus on the next tech upgrade, particularly in town driving features, the real world application for and by the AI. So we do believe that, the car parts makers will accelerate bringing the autopilot functions to Italian driving to the mass market passenger vehicles, the models the price below 30,000 for a starter.
We are looking for penetration of a level two plus a plus. How to apply that function to to 40% of new car sales this year. So implying roughly 6 million units of new car sales so that all sizes, the total size of any additions, the market, like in Japan or Korea.
So we do believe that such transformations in product upgrade, with the how to create idiosyncratic growth opportunities, to offset the exports tariff headwinds.
So as Andy mentioned already, I think starting from early days like 2015, some leading parts maker are aggressively expanding their production footprint in market like Asean, US, Europe, Latin America. So we believe first, such established production footprint, established production footprint, should entitle certain parts maker Chinese parts maker to greater, capacity to absorb the risk associated with a single market volatility especially it will be difficult for the car makers to locate sufficient quality local replacement.
Swiftly. So we do believe that, despite the trade tensions, it might be a good opportunity. And also, but, well, to these Chinese parts makers, global share. Okay. So that's my I'll take. Great. I mean, I guess maybe that dovetails well over to you, Chris, as we think about, you know, China no longer just exporting parts but exporting perhaps their manufac footprint into the rest of the world.
How are you seeing the opportunities set there for some of your names? And then as a secondary effect, as we start to drill in on on pricing as well, how does that impact, your sector right now?
Chris Snyder: Yeah. You know, I guess, you know, I think there's two things in that question that that position, my coverage as a relative lean more positive on these tariffs, than the rest, of some of the commentary we've heard, you know, the first is on that, you know, kind of changing global supply chains, you know, protect is the, I believe will drive more investment into the United States.
You know, and there may be it might come through on a lag. But ultimately it's narrowing the delta between the cost of U.S. production and the cost of international production. So I think the incremental, investment will start flowing to the U.S., and that's a very material positive offset for my company is, you know, maybe relative to other verticals, like, this will drive more investment.
They will benefit from that over time. And the second thing is pricing power. You know, I think my coverage has really positive, pricing power right now. If you go back to the Trump 1.0 tariffs in 2018 or 2019, the group collectively was operating profit accretive on the tariff, but it wasn't margin dilutive. So they made money on it, but not their normal margin.
You know, when I've talked to companies over the last 2 to 3 months, the the message was pretty consistent that the companies intend to be margin neutral on the tariff. So, you know, that's obviously very appreciative. And for it to be a net negative for the group collectively, you would have to assume that the the uplift in price is more than entirely offset by lower volumes, the demand elasticity essentially for it to be a net negative.
And if you look the last go around 2018 or 19, any kind of stock industrial production and PPI or inflation on top of each other, that was actually they grew into the tariffs, and relative to 2018 or 19, you know, I think US industrials have much stronger pricing power today. You know, I guess we kind of go back then, 2018 was really the first time they had a put through price in over a decade.
Since 2018, they basically haven't stopped putting their price in. And they've been very successful at it. So the view from the corporates is that the pricing muscle, the price data, they have to justify the asset is considerably better than it was, 5 or 6 years ago. And then just on top of that, the group still has excess backlog collectively, which supports, you know, pricing power and global investment is coming to the US, which again, supports their, their pricing power.
So you know, I was, you know, kind of a bit surprised at the magnitude of the negative reaction that we saw on Monday for the group. I'm not sure it's a net negative, for them, maybe I'll just pause there. Yeah, I guess maybe let's unpack that a little bit more on the pricing side of things, which verticals do you see having the best pricing power or the strongest backlog that they can leverage for that pricing power in today's market?
Yeah. No, it's a great question like the the incomings. And I think the focus from the market is very much been on who has tariff oft exposed, who's exposed to Mexico, who's exposed to China. When I kind of step back, I think the bigger question is who is pricing power? You know, this is a cost that's flowing through.
I think we want to own the companies with an ability to offset that. And I think that's positioned, to offset, the tariff. On the flip side, I would be more cautious on the consumer side. You know, the consumer has been under pressure already with inflation.
Generally the consumer is a bit more sensitive to price than, industrial, companies.
Great. Max, let's rounded up with you here in Europe, arguably, you know, there's still a lingering or looming risk that that Europe in and of itself might have to face tariffs.
But at the same time, a good number of your European cap goods have healthy footprints in the U.S., which is a very profitable market for them. And so, as you think about some of the opportunities that Chris outlined, do you share those views or do you see disproportionate risk to some of your names?
Max Yates: So I, I think you need to, I think you need to separates it between some of the electrical companies.
they've spent a lot of money expanding their grid equipment businesses in the US in the last 3 or 4 years, almost in anticipation that something like this could happen.
I think we're all companies are less well covered, is more the machinery names. Theyare exporters into the US. So I think it's actually our machinery names, particularly with those US competitors that are potentially more vulnerable.
So, so yes, I'd say there is a clear separation between the electrical and mechanical but I think I absolutely share Chris's point that our companies did a pretty good job with pricing power, didn't see margins go down in the first round of, of Trump's presidency.
And I think it if it if it is tariffs to these kind of 1,020% level it is manageable. I think where the magnitude start to get much more difficult where it can have a margin impact. If we start talking about sort of 20 60% from China.
Mark Van Der Pluym: Great. Thank you. Makes sense. And with that, I'll pass it back to you, Stephen. Thank you.
Stephen Byrd: Great. Thank you so much, Mark. Thanks, everybody, for participating. Today on our webcast,
