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John Engle
John Engle
Articles (186) 

Auto Stock Rally on Hope of China Tax Cuts May Be Overdone

Markets are reading more into the news than is justified

October 29, 2018 | About:

Auto stocks rallied virtually across the board on Monday, Oct. 29 on news that China’s National Development and Reform Commission, the country’s top macroeconomic policy management agency, had proposed a 50% cut in sales tax on automobile purchases. The proposal calls for a reduction in the prevailing sales tax of 10% down to 5%.

With the Chinese auto market flagging, the news was taken as a welcome sign by foreign stock markets, which sent auto stocks soaring.

Rejoicing across the industry

In the United States, top automakers Ford (NYSE:F) and General Motors (NYSE:GM) both shot up on the news. Since the Trump administration’s escalating trade tensions with China caused the People’s Republic to place a 40% tariff on car imports from the U.S., domestic automakers have been feeling a significant bite in their share price and have guided that slowing sales could produce significant headwinds for profits and growth.

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So the news was taken with great excitement, and not just in the U.S. The top German automakers also saw significant share price improvement, including Volkswagen (XTER:VOW) and BMW (BUD:BMW). Unfortunately, this ebullience may be somewhat misplaced. Certainly, any cut in final sale price will have a beneficial impact on demand, but it is important to remember the overall scale of the proposed reduction.

Less than meets the eye

While a 5% sales tax is certainly preferable in terms of demand stimulation, it does little to alter the punitive 40% tariff that still stands against American automakers. The Trump administration has given no indication it intends to budge on that score, so it may be too early for U.S. automakers to be celebrating. The net downward pressure on demand is still there.

For German and other foreign automakers, however, the cut could prove more wholly beneficial. When the Chinese government retaliated to U.S. trade policy with its 40% import tariff, it actually lowered the duty on other imported cars.

So the benefits flowing to the likes of Volkswagen and BMW in the Chinese market remain intact, and benefits equally compared to U.S. importers when it comes to the proposed sales tax reduction.

The fight is far from over

While a reduction in sales tax is a tacit recognition of the fact that the Chinese auto market is slowing down, it is far from an admission that it is the product of U.S. trade policy. If anything, a reduction in sales tax would demonstrate a willingness to stay the course by stimulating overall demand for car buyers without giving any particular relief to U.S. automakers.

Investors buying the current pop on the basis that the trade crisis may be turning the corner should think again.

Disclosure: No positions.

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About the author:

John Engle
John Engle is President of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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