Is a trade war about to erupt? That's the question that's rattling the stock market.
President Trump made it clear during his campaign that he felt the U.S. was at a disadvantage in its trading with several countries, especially China. On Tuesday, the White House proposed 25% tariffs on imports of around 1,300 Chinese products. China quickly retaliated, announcing its plans to impose 25% tariffs on 106 U.S. products. That move prompted President Trump to direct the U.S. trade representative to evaluate adding another $100 billion in tariffs against China.
Stock market indexes tanked on Friday with increased fears of a full-blown trade war between the U.S. and China. But are there stocks that actually perform relatively well in the midst of a trade war?
The easy answer
We could look back to trade wars of the past to determine which stocks, if any, thrived during those periods. The problem with that approach, though, is that every trade war is different. The U.S. trade embargo on Cuba imposed by President John F. Kennedy in 1962, for example, didn't at all resemble the current trade skirmish between the U.S. and China.
Another approach is to dissect the lists of products for which the U.S. and China are threatening to apply tariffs. President Trump wants to place tariffs on Chinese imports of aluminum and steel and products related to aerospace, communication technology, information technology, and robotics. China's list of products that could be subject to tariffs include agricultural commodities, aircraft, automobiles, and chemicals.
Could we just pick stocks that are in industries that don't market products on either nation's list? Not necessarily. There can be ripple impacts on other industries that might not be immediately apparent.
I think there is an easy answer to figure out what stocks could perform well in the potential trade war between the U.S. and China, however. We can just look at stocks that soared over the past week. Three of the week's biggest winners were AMC Entertainment (NYSE:AMC), CASI Pharmaceuticals (NASDAQ:CASI), and Senseonics Holdings (NYSEMKT:SENS).
It's important to understand why these stocks jumped while most stocks dropped over trade war fears. Let's start with AMC Entertainment. The theater chain announced the opposite of a trade war this week. AMC will become the first operator of cinemas allowed in Saudi Arabia after a 35-year ban. The company plans to open its first theater in Riyadh on April 18.
AMC also should benefit from some potential blockbuster movies on the way. Avengers: Infinity War hits theaters on April 27. AMC recently reported that advanced sales in the first 72 hours tripled those of Black Panther, which was also a monster hit.
CASI Pharmaceuticals is another example of the opposite of a trade war. The U.S.-based biotech is preparing to launch its cancer drug Evomela in, of all places, China. CASI announced on Thursday that an advisory committee in China will review Evomela later this month.
Senseonics Holdings is a small medical-device company focused on developing glucose monitoring products. Its stock surged on Wednesday after a Wall Street analyst issued a buy rating for Senseonics and set a one-year price target reflecting a huge premium above the current share price.
There are some common denominators with all three of these stocks. First, CASI Pharmaceuticals and Senseonics are small-cap stocks, while AMC is a borderline small-cap stock with a market cap of just over $2 billion.
Does that matter? Maybe. My Motley Fool colleague Brian Stoffel's recent interview with best-selling author Nassim Nicholas Taleb provides a good answer as to why. Taleb stated that he thinks small-cap stocks are more "antifragile" than larger stocks. By that, he meant that small-cap stocks can benefit more from chaos and volatility (like potential trade wars).
However, I don't think any of these three stocks are helped by a trade war with China. AMC Entertainment's single largest shareholder is the Dalian Wanda Group, one of the largest, privately held conglomerates in China. CASI Pharmaceuticals' fortunes are largely riding on approval of its cancer drug in China. Senseonics hopes to win patent approvals in China and ultimately target international markets with its glucose monitoring products.
So why did all three stocks move higher with escalated threats of a trade war? It boils down to another common denominator they share: All three had news that trumped (no pun intended) the U.S.-China story.
What to look for
I think that's the key for investors looking for stocks that can thrive in the middle of a trade war. You need to identify companies that could have news that is so compelling that an economic battle between two of the largest nations on Earth isn't as important.
What kinds of stocks fit the bill? Check out small-cap biotechs. Not all of them will be like CASI and depend on the Chinese market. Week in and week out, there are small-cap biotech stocks that skyrocket on good news about clinical studies, regulatory approvals, or potential acquisitions.
The problem, however, is that these small biotechs have their own risks. You'll need to be a very aggressive investor to be able to stomach the volatility, but there are several small-cap biotech stocks with great potential.
You don't have to limit yourself to just small-cap biotechs, though. Larger companies with less international exposure -- or at least less exposure to China -- could be poised to report terrific earnings over the next few weeks. A big spurt in earnings growth for a company that doesn't do business in China is likely to send a stock higher, even if a trade war starts.
Perhaps most important, though, is to invest in stocks of companies that are positioned for success over the long run. Trade skirmishes come and go. Remember also that so far it has only been a war of words and threats between the U.S. and China. There's a real possibility that the two countries reach an agreement that prevents a full-scale trade war from erupting. If that happens, we could see a rising tide lifting nearly every stock.