Four S&P 500 sectors are especially vulnerable as the U.S. trade war expands from China to Mexico and even to Europe, where additional tariffs on cars and auto parts are looming. Retaliatory tariffs from any of these trading partners will most likely affect companies in the information technology, materials, industrials, and consumer staples sectors due to their high foreign revenue exposures, according to Morgan Stanley. 

“Companies with high revenue exposure could see demand destruction from China’s tariffs on their goods,” wrote the bank’s analysts in their recently published report, “Global Exposure Guide 2019—U.S.” The report added, “They could also be hurt by a backlash against American products by Chinese consumers.”

4 S&P Sectors Caught in the Trade Wars

(Sector: percent of revenue derived from foreign sources)

  • Information Technology: 56% 
  • Materials: 47%
  • Industrials: 35%
  • Consumer Staples: 27%

Source: Morgan Stanley

What It Means for Investors

The first three of the above-mentioned sectors are cyclical, which means that a weakening of foreign demand due to escalating trade tensions poses an added threat as the current cycle ages and nears its end. Additionally, technology stocks have been one of the stock market’s biggest drivers. Given that the tech sector has the highest foreign revenue exposure, a fall off in demand will have a significant negative impact on the overall market indices.

Some examples of companies with high foreign revenue exposures include tech companies Qualcomm Inc. (QCOM) and Micron Technology Inc. (MU) with respective revenue exposures to China of 67% and 57%. Consumer staple company Philip Morris International Inc. (PM) and industrial company Wabco Holdings Inc. (WBC) have respective revenue exposures to Europe of 52% and 49%. Materials company The Mosaic Co. (MOS) has a 52% revenue exposure to Latin America. 

But it’s not just companies with foreign revenue exposure that will suffer from an escalating trade war. Companies with cost exposures that are unable to pass increased tariff costs on to consumers, find substitutes, restructure their supply chains, or cut costs elsewhere will face the threat of declining profit margins.

“We believe tariffs will press on margins,” wrote Morgan Stanley’s analysts. “Given other cost pressures and stubbornly low inflation, we are unconvinced that companies will generally be able to fully offset tariff costs through raising prices or through cost efficiencies elsewhere.”

Looking Ahead

Morgan Stanley’s analysts see tariffs on imports adding an additional risk to corporate profit margins, which have already seen some weakness as a tighter labor market is pushing up wage costs. While their base case scenario is that the escalating trade tensions is temporary, the bank’s analysts do admit a relatively high degree of uncertainty as to how trade talks will evolve and believe that in the case of 25% tariffs on all imports from China the U.S. economy could be tipped into a recession.