JPMorgan is now forecasting an all-out trade war between China and the US - and it could cause havoc for Chinese stocks

Oliver Contreras/Getty; Greg Baker/Getty; Shayanne Gal/Business Insider

US President Donald Trump and Chinese President Xi Jinping

• JPMorgan initiated a new base case for the trade war - tariffs on all trade flowing between China and the USA.
• "A full-blown trade war becomes our new base case scenario for 2019," a note from analysts including Pedro Martins Junior and Rajiv Batra said.
• This, alongside domestic factors, could push Chinese stocks lower.

The Trump administration is likely to proceed with tariffs on all China's imports into the US by some point next year, according to an analysis by JPMorgan published this week. If the prediction comes true, it could spell trouble for Chinese stock markets.

"We now assume US-China trade war enters Phase III in 2019, resulting in tariffs on all +$500bn of imports from China," the note, by analysts including Pedro Martins Junior and Rajiv Batra, said.

So far, the Trump administration has placed tariffs on $200 billion worth of Chinese goods, affecting more than 5,000 products. The president has made clear he is willing to "Go to 500" - a colloquial term for placing tariffs on all goods imported to the US from China.

That threat was previously seen as bluster, but people have started to take it seriously after Trump escalated the dispute with levies on a further $200 billion of Chinese goods.

"The $200bn tariff on Chinese imports and retaliatory tariffs on $60bn of US imports are in place," JPMorgan wrote. "There is no clear sign of mitigating confrontation between China and the US in the near term."

JPMorgan now has an all-out trade war as its "base case" - meaning the bank believes it to be the most likely outcome.

As a result, JPMorgan downgraded its outlook for Chinese stocks from overweight to neutral. The bank thinks the trade war will have a negative impact on China's economy and, as a result, hit stocks.

"Total impact on China's GDP growth is 1.0%, if China does not take countermeasures," the team wrote, continuing:

"The direct impact (-0.3%) is mainly via the hit on China's exports to the US (both price and volume effects), while China's imports would also decline as foreign content accounts for about one-third of China's gross exports (importing intermediary products for the purpose of exporting). The indirect impact is via consumption (-0.2%), investment (-0.5%) and sentiment (-0.4%). Higher tariffs are squeezing Chinese manufacturing's profit margin, reducing the investment incentive and hiring, which would then drag on consumption via reduced income."

Assuming both the US and China place tariffs of 25% on all imports, the hit to earnings of companies included on the MSCI China index would be 2.6%, with growth slowing from 15% to 12.3%.

"China sectors such as energy, IT and industrials will be most impacted based on our analysis, while sectors such as real estate, insurance, diversified financials, telecom and utilities generate virtually no revenue from the U.S," the team wrote.

JPMorgan said that while the trade war is the biggest factor in downgrading Chinese stocks from overweight to neutral, it is not the sole reason.

The lender also listed a "higher equity risk premium due to risk aversion and increasing government activism, further CNY [Chinese yuan] depreciation, and uncertainty in China's reform agenda," as possible drivers of negativity in the Chinese stock market.

JPMorgan is reducing its end of year target for the MSCI China in 2018 from 95 to 85, and reducing exposure to financials to mitigate any risks.