Excess Returns Podcast: "What Investors Get Wrong About Trade Wars" | Guest: Kai Wu

Date: May 14, 2025

Episode Overview

In this visually-driven and data-rich episode, the Excess Returns team is joined by Kai Wu, founder of Sparkline Capital, to dissect the practical realities and investment implications of recent trade wars. With a focus on the empirical data from his research paper "Investing Amid Trade Wars," Kai tackles prevailing misconceptions among investors, particularly the rush to abandon globally-exposed firms in favor of of domestically-focused companies during periods of trade policy uncertainty. He explores the historical context of tariffs, nuances in global business models, resilience strategies for investors, and how intangible assets play a pivotal role in today’s globally interconnected markets.

Key Discussion Points & Insights

1. Context and Motivation: Revisiting Trade War Panic

[02:32]

• Kai’s Motivation: Kai wanted to challenge the knee-jerk investor reaction of fleeing from global companies in the wake of “Liberation Day” and subsequent tariff hikes.
• Investor Behavior: Example given: Restoration Hardware plunging 40% in one day—showcasing how fear-driven market moves often ignore the robust performance history of multinationals.
• Approach: Kai built a new metric for global trade exposure, categorizing companies as domestic or global, and found that global firms tend to be higher quality and more profitable.

“Global companies have and are currently a lot more profitable and higher quality businesses than their domestic counterparts. ROEs are basically 2x.” — Kai [00:00, 02:32]

2. Historical Context: How Unprecedented Are These Tariffs?

[05:51]

• Reviewing a chart of US tariff rates from 1820 to present, Kai notes the recent spike is historically significant.
• The average tariff rate recently reached heights not seen in over 120 years.

“To the extent where the average tariff rate were to be raised to levels not seen for 120 years since 1900, that is a significant, that is a really big deal.” — Kai [06:46]

3. Objectives and Policy Fragmentation

[08:26]

• Tariff motivations are multifaceted: fairness, reshoring, reducing trade deficits, and sometimes revenue generation.
• Political coalitions are fragmented and sometimes internally contradictory, making prediction difficult.

“It doesn't even feel like ... there’s even a cohesive understanding within the Trump cabinet, let alone amongst ... average public market investors.” — Kai [09:14]

4. Multinational Dominance Among Leading Companies

[10:35, 12:46]

• Most of the world’s largest firms by market cap are truly multinational (Apple, Microsoft, TSMC, etc.), deriving half their revenue and much of their production and employment overseas.
• 80% of the S&P 500 are global companies (multinational, exporters, or importers).

5. Defining Global Exposure: The 2x2 Matrix

[14:42]

• Companies are categorized by where they produce and where they sell:
  • Multinational: Global production & sales (e.g., Novo Nordisk).
  • Domestic: Local production & sales (e.g., UnitedHealthcare).
  • Exporter: Local production, global sales (e.g., luxury brands).
  • Importer: Global production, local sales (e.g., Cognizant).
• The auto industry is highlighted as especially international, blurring traditional notions of “domestic” brands.

“Companies are more than just where they happen to be based or even listed on a stock exchange.” — Kai [17:16]

6. Why Global Firms Outperform

[19:18, 20:23, 26:28, 29:12]

• Empirical Outperformance: Backtests show that, across both market cap and equal-weighted approaches, global companies have consistently outperformed domestics for 15 years.
• Drivers: Larger markets mean economies of scale, lower production costs, and access to specialized skills (e.g., semiconductors, Swiss watchmaking), as well as selection bias—only top-tier firms can compete globally.

“If you were a top tier company, then you're going to want to play on the global stage ... The returns to being successful are higher, but also the competition is higher.” — Kai [27:42]

• Profitability: Global firms exhibit stronger financials—higher ROEs, margins, and consistent quality through time.

“Global firms, as of March 31, 2015, are significantly more profitable than domestic firms ... this is pretty consistent over time.” — Kai [29:12]

7. Sector and Geographic Insights

[23:15, 22:23]

• Sector Exposure: IT (particularly hardware), materials, industrials, and healthcare have the highest global exposure. Utilities, real estate, and financials are more domestic.
• Geographic Differences: European firms are actually more multinational than US companies, with China and India lagging due to their large internal markets.

8. Trade Policy Uncertainty and its Impact on Returns

[30:08, 31:25]

• The Trade Policy Uncertainty Index hit all-time highs post-Liberation Day.
• When uncertainty spikes, global firms temporarily underperform, suggesting a risk premium is embedded:

“Maybe there is a geopolitical risk premium. And that could be one of the reasons ... these stocks have outperformed over the past several decades.” — Kai [32:22]

9. China Exposure and Resilient Supply Chains

[33:32, 40:09]

• Measuring Exposure: Kai’s team employed large language models and employment data to estimate corporate exposure to China.
• Peak exposure to Chinese production was actually reached in 2009, with a slow shift to “China+1” strategies since then (diversifying into Vietnam, India, etc.).

“The Flexibility of these multinationals to be able to kind of redeploy supply chains ... has been going on for ... 15 years.” — Kai [37:44]

• Resilience: Global companies with the most diversified and aligned supply and sales footprints (measured with the Hirschman Index) have performed best.

10. Intangible Asset Advantage

[43:06, 44:52]

• Global firms are much more intangible-asset-heavy (R&D, patents, marketing) than domestic ones, giving them scalability, tax advantages, and protection from tariffs.

“Intangible companies, you can't really tariff an intangible asset. Purely digital businesses, services businesses ... are not really able to be tariffed.” — Kai [45:42]

• The strongest historical returns came from globally-active, high-intangible firms.

11. International Stocks: Opportunity and Discount

[48:59]

• Non-US global firms (e.g., ASML, Samsung, Toyota) are as competitive as US peers but trade at an estimated 40-50% valuation discount.
• Lower EPS growth in non-US firms mostly stems from less intangible investment, not inherent weakness.

“These are companies ... that are as good, if not better in some cases than their US counterparts. Yet they traded a huge discount simply because of the accident of where they're domiciled.” — Kai [50:25]

Notable Quotes & Memorable Moments

• On Investor Behavior:

“We saw this repeat of the movie we've all seen many times before, where investors tend to panic ... and instinctively start to turn away from stocks with global trade exposure and instead hide in domestic companies.” — Kai [02:32]

• On Globalization’s Persistence:

“Free trade is here to stay ... The cost of not having it is too high.” — Kai [00:55, 53:24]

• On Uncertainties:

“The uncertainty is the main killer. ... Because it changes so rapidly, it's kind of a wait and see for now.” — Kai [18:50]

• On the Intangible Edge:

“If you're looking for a way to own global companies but then also have more resilience in the face of tariffs, the intangible subsets of these global companies could be an interesting place to look.” — Kai [47:09]

• On the Final Takeaway:

“Taking a longer term view, staying the course, continuing to focus on what's got us ... (to) success so far, which are these kind of high intangible global oriented companies ... I think free trade is here to stay whether we like it or not.” — Kai [53:04]

Practical Investor Takeaways

Kai’s Four Recommendations for Navigating Trade Wars:

1. Favor Global Firms with Low Chinese Production Exposure:
   Reduce risk of disruption by limiting exposure to regions most targeted by tariffs.
2. Seek Firms with Diversified/Resilient Supply Chains:
   Companies with flexibility and regional balance (e.g., Tesla's localization strategy) fare better.
3. Prioritize Intangible-Heavy Businesses:
   These are less vulnerable to tariffs as digital goods/services cross borders more freely.
4. Include Non-US Global Firms:
   They provide diversification, political risk reduction, and currently trade at steep discounts.

Concluding Thoughts

• A long-term, data-driven approach shows that abandoning global firms because of cyclical trade policy uncertainty is short-sighted.
• Political risk premiums and disruption are real, but history and data suggest that globalization adapts, rather than retreats.
• Investors benefit from continued allocation to high-quality, intangible-heavy global companies while tilting portfolios for resilience against new risks.

For deeper visual context, check out the corresponding charts on the Excess Returns YouTube channel.