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Investors could see steep drops in global stock markets if tensions between China and the United States escalate into a full-blown trade war, analysts at UBS said in a note Friday.
Assuming virtually all trade between U.S.-China is affected by tariffs and other protectionist policies, the Swiss bank calculated that profits for firms would take a 14.6 percent hit, with U.S. and global growth being 245 and 108.5 basis points lower, respectively.
However, the bank noted there would also be second-order effects. These "would be larger, with U.S. multinationals doing business in China also likely to be hurt by China retaliation." Thus, in terms of company valuations, these would take an additional 9.1 percent hit, bringing a total downside of 21.3 percent for the U.S. benchmark after some further adjustments by UBS analysts.
So far this year, President Donald Trump has imposed new tariffs on Chinese solar panels, washing machines, steel and aluminum, as well as on other imported goods for intellectual property theft. China has retaliated every time. However, there are more potential tariffs on the way, with Trump threatening to impose new levies worth as much as $200 billion.
David Riley, the chief investment strategist at BlueBay Asset Management, told CNBC's "Street Signs" Friday: "If I was sitting in Beijing, I would be pretty worried."
"I think we are going to get potentially more tariffs imposed on China coming at the end of the month, or early September," he said.
UBS analysts warned Friday that equity investors are not preparing for a trade war scenario, mainly due to recent statements from U.S. and European leaders.
On Wednesday, Trump and European Commission President Jean-Claude Juncker struck a conciliatory tone that put an end to fears of imminent tariffs on European cars. European stocks rallied on the news. However, the agreement didn't eliminate the prospects of new tariffs at a later stage.
"Equities are not yet discounting a trade war scenario and we see a 20 percent-plus decline driven by a combination of lower earnings and multiple contraction (which means that markets will start paying a lot less for the same amount of earnings)," UBS noted.