RBC: Mexico tariffs will drive stock market into correction territory this summer

KEY POINTS

• "The potential for tariffs on Mexico make it even more likely that the S&P 500 will fall to 2650 this summer, taking the index 10% below its April 2019 high," RBC Capital Markets' head of U.S. equity strategy says.
• The S&P 500 is already down more than 6% from its high in April.
• PepsiCo, Union Pacific and Sempra Energy have more than 5% of their revenues from Mexico, making them more exposed than other companies to this trade battle.

Semi-trucks cross the border at the Zaragoza International Bridge, in Juarez, Mexico, across the border from El Paso, Texas on May 31, 2019.

Paul Ratje | AFP | Getty Images

In a "two front trade war" the market may find correction territory, according to RBC Capital Markets.

In an escalated trade war with China and now Mexico, U.S. equities may fall 10% from their recent highs, Lori Calvasina, the firm's head of U.S. equity strategy, said in a note to clients Monday.

"The potential for tariffs on Mexico make it even more likely that the S&P 500 will fall to 2650 this summer, taking the index 10% below its April 2019 high," said Calvasina. The bellwether index was at 2,746 Monday morning, down 0.2%.

Last week, President Donald Trump announced the United States will impose a 5% tariff on all Mexican imports starting on June 10. The president said these levies will stay in place until the Mexican government does more to stop illegal migrants from entering the U.S.

Trump's tariffs on Mexico come after a broken trade deal with China caused the president to hike tariffs on $200 billion worth of Chinese goods. In retaliation, China put tariffs on $60 billion worth of imports.

The S&P 500 is already down more than 6% from its high in April.

To get a sense of which sectors in the U.S. equity market are most at risk during an escalated trade war with Mexico, Calvasina tracked companies that mentioned Mexico on earnings calls in the fourth quarter of 2016, following Trump's victory in the election, and the third quarter of 2017, during NAFTA renegotiations.

The energy, materials and consumer staples sectors have the most entanglements with Mexico, Calvasina concluded, and utilities, financials, health care, REITs, tech, and communications have the least.

RBC also evaluated companies with greater than 5% revenues from Mexico.

"Nearly two-thirds of the names that we've identified as getting at least 5% of their revenues from Mexico underperformed the S&P 500 on Friday, the first full trading session after the Mexico tariff news broke when the broader market fell 1.3%," said Calvasina.

Lear, Kimball Electronics and American Axle & Manufacturing have more than 5% of their revenues from Mexico and were all down more than 5% on Friday.

PepsiCo, Union Pacific and Sempra Energy are also on the list.

Calvasina said for now, she thinks the Mexico tariffs won't go past the 5% level but the markets are bracing for the worst.