Investors should beware flare-up in US-China trade war

Market euphoria ahead of the US-China trade deal signing in January is misplaced, say analysts and fund managers. They believe asset owners should remain cautious.
Investors should beware flare-up in US-China trade war

The lack of detail about the imminent trade deal signing between the US and China is a cause for concern and asset owners should tread lightly, say investors.

US president Donald Trump said on New Year’s Day that the US and China would sign a "very large and comprehensive" trade deal at the White House on January 15, though exact details of the agreement were not released. China has been noticeably silent on the matter.

The initial announcement that the two sides had reached an agreement, in mid-December, came just as Trump was impeached on two counts by the House of Representatives. Observers believe political calculations, rather than economic outcomes, are dictating the timing of the deal.

Andy Rothman, Matthews Asia

Andy Rothman, investment strategist at Matthews Asia, told AsianInvestor: “Some time ago, Trump reached the conclusion that a deal is much better than no deal for his re-election prospects.”

The trade agreement would help to roll back some of the trade tariffs each nation has built onto the other's exports, following Trump's decision to start doing so in 2017.

US officials claim there is a lot of enforceable detail in the 86-page trade deal, but so far scant information has been made available about its terms and conditions. 

"We still don’t have enough to really evaluate the deal," noted Rothman. "The Chinese have not released any details at all. They have neither confirmed nor denied the $40 billion to $50 billion of agricultural exports. So it could be that there are, in fact, issues outstanding."


Other fund manager observers were also sceptical about the impact of the nascent agreement.

Gregory Daco, chief US economist at Oxford Economics, said any euphoria about the announced deal was misplaced.

“It is hard to believe that either business leaders or consumers will react strongly to what is a frail trade agreement — and one that comes with strings attached,” he said. He added that the risk of a bleaker outcome in 2020 is still high.

Libby Cantrill, the head of public policy at California-headquartered fund house Pimco, said in a note on the trade deal on December 20 that investors should remain cautious, describing Phase 1 of the US-China trade deal as “more of a fragile truce than a permanent settlement”.

She added that the deal should see no additional tariffs and a small de-escalation, with tariff rates on $120 billion of goods being cut from 15% to 7.5%, as well as some movement on issues such as intellectual property and goods purchases. However, there are several other areas yet to be negotiated.

“Many of the knottier, harder-to-agree-on structural issues have been shelved for Phase 2 negotiations (e.g., the subsidising of state-owned enterprises)," Cantrill noted. "As such, we expect tariffs to remain on at least some Chinese imports for the foreseeable future.”

She added that tensions could flare up once more later this year, especially if China doesn't stick to its commitment to purchase US goods – commitments it has said it would adhere to only if there is market demand and conditions supported them.

Rothman said the numbers that have been released on import/export targets that the US wants China to meet are cause for concern.

US trade representative Robert Lighthizer said the Chinese government has committed, in writing, to double imports of goods from the US. In terms of the agriculture numbers, the US claims to have a commitment for $40 billion to $50 billion in sales.

Rothman thinks this is unrealistic, to the point of setting the whole thing up to fail.  

“US agricultural exports to China peaked in 2012 at $26 billion, and none of the American agricultural experts I've consulted think it is possible to double that in the near future,” he said.

“My contacts in Washington say that the $40 to $50 billion target was not based on a detailed assessment of China's demand, nor on the ability of American farmers to quickly expand output of soybeans and other crops. It was a politically expedient target. The concept of quickly doubling the value of overall US exports to China is equally dubious.”

If the targets are unrealistically high, Rothman predicts the US will at some point in 2020 complain that China is not meeting them, "and the whole thing falls apart – that will leave us worse off."

In addition, investors are only likely to view an eventual trade deal as a success for US companies if Trump's negotiators make breakthroughs on issues they have focused on for the last few years. But Rothman said he doesn't think Beijing feels overly pressured to make too many concessions. 

"I don’t believe that growth is materially slower than it would have been without the tariffs. China has more room to cut rates, they don’t have the political obstacles they have in the US to fiscal stimulus."


Asset owners remain cautious about the implications of the US-China deal. Australia’s Future Fund has moved its portfolio to a much more risk-averse position amid the financial volatility sparked by the US-China trade war.

The fund's chairman, Peter Costello, told AsianInvestor last year that any further prolonging of the trade war would cause market sentiment to deteriorate.

“If you really thought that this was going to be a long and entrenched war, which would lead to effects on the real economy, then you would be building a lot more downside into these valuations.”

For institutional asset owners, it’s not only about the underlying economic concerns raised by tensions with China, but how it directly affects their relationship as investors in large private assets.

New Zealand Super, for example, was able to divest the bulk of 11 forestry blocks in the North Island valued at over $90 million, to a subsidiary of state-owned China Forestry Group Corp, in 2018. If China is increasingly isolated as a result of the trade war, such deals could be harder to achieve.

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