What was actually decided?
Presidents Xi and Trump finally met at the G20 Summit in Buenos Aires last Saturday. It's the first meeting of these two leaders since the trade war broke out earlier this year. We wish we could tell you that everything is fully resolved in this festive season and that both the US and China will “trade” happily ever after. Unfortunately, it's not that simple.
They did agree to a 90-day halt on further tariff hikes. China also agreed to buy agricultural, energy, and industrial goods from the US to reduce the trade surplus. More importantly, they will now begin discussion on key topics to both sides, including technology transfer, intellectual property protection, non-tariff barriers, and cyber theft.
How do we interpret the situation?
It is most certainly not an end to the trade war. That said, it is a relief that things did not escalate. To be honest, few investors expected a complete cease-fire. It is reasonable that the US and China are now initiating further discussions with both sides eager to have a proper relationship in bilateral trade.
To put things in perspective, let’s quickly recap the significance of China’s direct trade with the US. In 2017, China shipped USD 2.3 trillion worth of products around the globe. Roughly half (49%) of Chinese exports by value were delivered to Asian countries, while 22% were sold to North America and 19% were shipped to Europe. The rest went to Latin America and Africa. That means it will take years for the US and China to adjust their import and export trade, i.e. the US will look for new suppliers such as Mexico, Canada and Southeast Asia while China will look for new customers across Asia Pacific, Middle East and Africa, and Europe.
Implication to the market
Markets are likely to reward the de-escalation and the immediate negative impact of higher tariffs to the real economy might be deferred. Basically, the risk premium of China and the overall emerging markets will likely come down. Instead of focusing on news headlines about the trade war, investors can now go back to fundamentals and reallocate assets accordingly.
Some may believe that a 90-day halt simply kicks the can down the road without providing any clarity. That may in fact be the case if the purpose of the trade war is not about balancing the trade deficit but about maintaining US dominance globally. With China growing at a rate much faster than the US, with or without the trade war, continuing conflicts between these two leading countries are likely. If it is not trade, it could be something else like human rights, climate change, intellectual property, military related issues, etc. Instead of worrying about the US and China relationship, we believe investors will gradually accept it as the new normal, creating short term uncertainties around specific events but not impacting fundamentals and valuations (i.e. no real market impact) in the long term.
important to remember the real triggers of China’s sell-off this year:
deleveraging at the very beginning, followed by the additional issues of
the trade war. While everyone has been focused on the latter, the
Chinese government is already fine-tuning its deleveraging policy. Going forward, weak trade data will be countered by strong fixed asset investment numbers in order to balance economic growth. Fiscal
policy to reduce both personal and corporate tax will help lift
sentiment and support domestic consumption and private investment.
What should investors do?
A few contrarians have already front-run the market and began investing in China and Asia before the G20 Summit. They saw valuations getting quite attractive after the sell-off. In addition, US market volatility since October led some investors to take profits in the US and adjust their portfolios to more global allocations. The majority, however, have adopted a wait-and-see approach, looking particularly for a rebound in macro numbers. While being prudent and patient is a good character, we do have to realize that markets usually reward those who are optimistic and willing to take calculated risks. If everything becomes certain, the market will have priced in all the facts and the upside would be rather limited.
It’s important to remember that China’s sell-off this year was not caused by the trade war or tariff hikes, but the progression / evolution of events that caught investors by surprise. The mismatch in expectations created a panic that drove investors to grudgingly cut risk despite decreased valuations. We believe that the gap between trade war expectations and the potential outcome has narrowed significantly. No one expects a smooth US and China relationship going forward.
A smaller expectations gap means that in the near-term, despite market volatility remaining, investors will start to revisit fundamentals such as earning prospects and valuations instead of avoiding China outright. The change from over-tightening to accommodative policy should be welcome news for China’s market. Please do not misread it, however, as a U-turn away from structural change – it is simply a change of gear to support the economy. In addition, next year is the 70th anniversary of the People's Republic of China. Maintaining healthy economic growth and strong capital markets is obviously in line with the overall agenda of the Chinese government. Necessary actions to improve the economic environment will be taken in coming months. In terms of sector exposure, we believe that technology transfer will become a more important topic going forward. It is likely that we’ll see more supportive policy in emphasizing innovation and developing home-grown technology going forward.
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