The global stock market took a hit last week following the U.S. President’s proposal of an imposition of a 24% tariff on steel imports and a 10% tax on aluminum imports.
Though Trump’s decision is aimed at keeping a check on foreign imports and boost jobs in the country, possibility of a global trade war stemming from the same provided a severe jolt to the share market. In fact, post the declaration, many companies’ share price (except steel and aluminum makers) slumped on Mar 1 on the fear of reeling under higher prices for inputs.
Why Should the Aerospace Majors Worry?
Aluminum and steel are the basic raw materials required for the manufacturing of aircraft as well as other defense products like rockets, missiles, tankers to name a few.
According to the U.S. Geological Survey, operational aluminum smelters in the United States have declined from 23 in 1993 to five in 2018. Per a Commerce Department report only one of these smelters make the high-purity aluminum needed for fighter jets.
Aircraft manufacturers as well as defense majors rely on foreign imports to develop high-end weaponries. Per a report by The Washington Post, U.S. companies import 90% of aluminum that is needed to manufacture products as diverse as beer cans and fighter jets.
However, steel, in the United States, is used to a much lesser extent by Aerospace companies, when compared to aluminum. Per The New York Timer, the United States imports only about one-third of its steel required for manufacturing jets and defense equipment.
Therefore, the imposition is likely to have a significant impact on the major players in the U.S. Aerospace & Defense space.
Implication of the Tariff: Experts View
The U.S. Defense Secretary James Mattis supported Trump’s decision. However, he is of the opinion that the move should come through a system of targeted tariffs and import curbs on aluminum can be put on hold for now.
He added that direct defense needs account for only about 3% of U.S. production. The proposed curbs will not dent Pentagon’s ability to obtain steel and aluminum needed to meet national defense requirements.
However, the Aerospace Industries Association believes that the imposition might lead to a marketplace retaliation and has thus extended a critical review of the tariff plan. In particular, its CEO believes that the tariff will adversely impact the Aerospace-Defense space by raising costs and disrupting supply chains, putting the U.S. global competitiveness at risk. According to him, the U.S. aerospace and defense industry generates more than $86-billion net surplus a year — the highest in the manufacturing sector. Therefore, the tariff, if imposed, will surely affect the industry and in turn the economy.
Trump’s latest announcement has not gone down well with the foreign allies of the nation. The European Union has already announced plans to impose higher tariffs on Harley-Davidsons, Kentucky bourbon and bluejeans, if this tax comes into effect.
Stocks in Focus
Following Trump’s announcement, Lockheed Martin Corp.’s (LMT - Free Report) stock fell almost 4%, The Boeing Co.’s (BA - Free Report) stock declined 3.5% and General Dynamics Corp. (GD - Free Report) shares dipped 1.4% on Mar 1.
Aluminum is one of the three most important raw materials that Boeing requires for the manufacturing of aerospace products. According to several experts, the company uses aluminum for the manufacturing 80% of older models like 737 and 777 which accounts for 12% of the cost. However, most of the aluminum Boeing uses is domestically produced and only around 25-30% is imported. So the tariff may hike the cost of a plane by 0.3%. On the other hand, many fear that prices of domestic aluminum is likely to rise if the tariff is imposed and in turn weigh on the company’s sales.
Moreover, with Boeing operating a diverse business globally, Bloomberg believes that it remains most susceptible to a possible trade war as a result of this tariff.
For Lockheed Martin as well, aluminum is an important raw material. The company’s CEO remains concerned over the impact of the proposed tax on the company’s growth. The company, which relies on sales to foreign allies, remains worried because Trump’s latest plan could hamper those relationships as well as lead to marketplace retaliation.
Meanwhile, Lockheed is likely to clinch a long-term purchase agreement which would cushion it against the proposed US steel and aluminum tariff until 2021 (per the Financial Times).
On Mar 2, the governor of Virginia warned that Trump's plans to impose tariffs on steel imports will hurt defense shipyards like Newport News, which is building America's next class of aircraft carriers. This in turn may adversely impact shipbuilders like General Dynamics.
The primary objective of the tariff imposition is to create jobs for Americans, yet there remains a fallacy in the policy itself. While American steelmakers lost “three-quarters of their jobs” between 1962 and 2005, a major study by the American Economic Association revealed that much of this had been due to improved production technology as output per worker rose fivefold. Thus, declining domestic demand was not the prime reason for the rising unemployment rate. So the latest tariff now will most likely not boost the domestic job market to the extent that Trump expects.
Despite this, if it is imposed the aerospace defense stocks will be affected, at least in the initial days. This is because that not only it will make imported steel and aluminum dearer, but also will push up the cost of its domestic counterparts, putting these stocks at a competitive disadvantage compared to their foreign peers. Yet, considering the fact that America is the largest supplier of defense equipments, the major players in this industry including those mentioned above are expected to turn around in the long run.
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