Market Views: Trump’s rising “capital war” with China

Washington's growing opposition to US investment into Chinese assets is affecting asset owners and has wider implications too, note market experts.
Market Views: Trump’s rising “capital war” with China

With the US election scheduled for November, President Donald Trump has dialled up his anti-China rhetoric to fever pitch, and it appears to be having an impact on the investment industry.

Last week it emerged that a $600 billion government pension fund had halted a plan to transfer some $50 billion of its investments into a portfolio tracking an index that included Chinese stocks. The move by the Federal Retirement Thrift Investment Board (FRTIB) came after sustained pressure from the federal administration and Congress. 

Some have raised concerns that the impact could spread to the wider investment community. In fact it may already have done so: US aerospace company Lockheed Martin's pension fund decided last year to close its investment office in Hong Kong in what some believe was at least partly in response to the political environment. 

Moreover, ramping up his criticism of Beijing’s handling of the coronavirus, Trump said last week that he would not renegotiate the trade deal agreed in January after last year's tariff war. And some believe he will impose more tariffs before November.

Other mooted measures include removing Chinese companies from American supply chains and requiring those listing on US stock exchanges to comply with local accounting standards.

In a Fox News interview last Thursday (May 14), Trump even raised the possiblity of cutting all ties with the world’s second-largest economy.

Whether such developments materialise or not, such discussions are complicating the investing environment in the US and beyond and raising concerns about potential economic retaliation from Beijing. 

Four experts provided their thoughts on the potential implications for investors in the US and beyond and the relationship between the world's two biggest economies.

Lionel Johnson, president
Pacific Pension & Investment Institute (San Francisco) 

Lionel Johnson

It would make sense [for the US] to get back to a strategic sustained engagement with China. Clearly, the strategy [of pursuing a trade war] in the past year has not worked effectively and has not really served either side.

Our members [of the Pacific Pension & Investment Institute] that invest in China have a long-term view. But we need to get back to an environment that is conducive to investment discourse, political discourse and where travel is possible again.

There have been a few isolated instances recently [of US institutions holding off or rethinking investments into China, like the FRTIB]. After all, decisions aren’t made in a vacuum – heightened political pressure can have an impact.

But it’s short-sighted on the [US] government’s part. Why would you prevent federal employees from having the same investment opportunities as other private citizens?

I am hearing concerns that this could be a slippery slope and could become problematic. It would be a dangerous road to go down.

It’s important for the US to remember that foreign direct investment is important for improving our own economy. If you begin to take punitive measures, there may be a retaliatory policy that could be enormously dangerous for the bilateral relationship but also for the international investment environment. 

Elliot Hentov, head of global macro policy research for official institutions
State Street Global Advisors

Elliot Hentov

[The push to restrict FRTIB's investment] is more about the signalling effect on US-China geopolitical confrontation than about the actual capital being deployed or obstructed. In practice, the move only prevented a reallocation to a different index with a higher Chinese exposure, with the ultimate sums reaching the Chinese market being marginal.

The signalling effect, however, is large, as it confirms we are moving beyond trade wars to capital wars. Asset owners will, therefore, continue to adapt their portfolios to a deglobalisation mindset that favours home bias and regional concentrations. The shift will be gradual and asset managers are likely to support this with a range of products that reflect a variety of index composition.

A rough calculation was for China to be enjoying equity inflows of about $50 billion and bond inflows of about $100 billion per year in the medium term as a result of their inclusion in global indices. These figures are unlikely to drop materially, as Chinese assets continue to offer diversification and other portfolio benefits.

[President Trump’s intervention] could, however, mean that some US investors limit their exposure in fear of reputational risks or in anticipation of governmental guidelines.

George Magnus, research associate
Oxford University’s China Centre and London's School of Oriential and African Studies 

George Magnus

President Trump’s intervention in the investment strategy of the pension fund strategy of US federal employees adds ‘financial’ to the many words that already precede the word ‘war’ with China, including trade, technology, values, and cold.

By also considering breathing life into a stalled piece of legislation designed to threaten Chinese companies with delisting from US exchanges if they do not comply with US accounting standards, the White House is taking some big risks, mainly for US firms and markets.

The issue is the context of blame for the pandemic in which these initiatives sit, not the measures per se. By politicising them so overtly, the government risks not only retaliation by – and still frostier relations with – China, but also a blow-up of the tentative trade deal reached in January, and a contagion of market angst into the wider investment community. Any or all of these could have market-wide negative repercussions.

Specifically, if the White House forbids [FRTIB] from investing in Chinese firms only, investors will lose dividend income. More widely, investors may fear new securities or capital markets rules and regulations that will interfere with their commitments to investors and investment benchmarks.

Louis Kuijs, head of Asia economics
Oxford Economics

Louis Kuijs

Even as political relations between China and western countries have worsened, especially in the case of the US, foreign investors have generally responded favourably to Beijing opening financial markets, bringing in sizeable bond and equity investment.

Looking ahead, given the broad support in the US for a tough attitude towards China across the political spectrum, political tension is likely to remain, even if a new president were to be elected this year. It is too early to say for sure whether foreign financial investment can continue to grow in such an environment.

But the enthusiastic response of US and European financial institutions to the opening up of China’s insurance and wealth management markets suggests that the political tension may not necessarily stand in the way of further increases in foreign investment in China in search of decent returns.

Richard Morrow contributed to this article.

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