“The political object is the goal, war is the means of reaching it, and means can never be considered in isolation from purpose.” — On War, Carl von Clausewitz,
The trade dispute between the US and China will deteriorate before it improves. The jarring re-pricing of technology stocks has further to run. And normalisation of central bank policy will continue to spook the bond market.
Why then, am I still positive towards risk? And why do I see currently weak investor sentiment and poor market price action as a buying opportunity?
Let me explain. Much of the current market uncertainty – including the tech wreck – relates entirely or partially to escalating trade tensions between the US and China, and the prevailing fear that an all-out trade war could tip the global economy into recession, causing subsequent carnage in the market.
It’s why – over the last week or so – the MCSI China Index is down 4.2 per cent, the Hang Seng is down 3.5 per cent, and the S&P is down 3.9 per cent.
And of course, were an all-out trade war between the world’s two largest economies erupt, then almost certainly the global economy would encounter severe headwinds. And almost certainly a bear market would ensue.
The thing is, I do not buy the “all-out trade war” narrative. I think the market has overreacted. Granted there are undeniable risks, but on balance, I envisage a negotiated trade settlement as being by far the more likely outcome, as I discussed in my previous column two weeks ago.
Like all investment decisions, there are both risks and rewards to balance and assess; but overall, my sense is risk appetite will recover, and in months, if not weeks from now, equity markets will be trading higher.
For all of the bluff and bluster by US President Donald Trump, I believe he has a clear political objective in mind: being the reciprocity of access.
This is why trade tariffs are being levied; it is why the Section 301 investigation was launched, and it’s why reciprocal, mirror taxes are being mooted.
In fact, I see the US’s trade war as one very large and very powerful crowbar designed to prise open China’s tightly guarded domestic market to greater foreign – read American – exports.
And the reason I think the US will succeed in achieving this aim is because Beijing realises how serious Washington and Corporate America are in seeking to fundamentally reset their bilateral terms of trade.
First, it’s important to understand the depth of animus held in the US towards China’s trade practices which are seen variously as distorted, predatory, and unfair. Under Trump, such frustrations have come to a head and found a voice. From rust belt workers to business leaders, from Silicon Valley IT firms to the halls of government, the impulse to “get tough on China” is broad-based and increasingly vocal.
Not surprisingly, China is treading cautiously. In response to the US plan to levy tariffs on up to US$60 billion of imports from China, Beijing responded with countermeasures equivalent to a rather timid US$3 billion, albeit with a promise to do more if further provoked.
The problem is, when you racked up a monster trade surplus with the US approximating US$280 billion in 2017, it’s a challenge to sound convincingly on the side of angels.
Yet ironically – for now at least – the US tariffs are a side show, a commercial irrelevance equivalent to less than 0.1 per cent of China’s gross domestic product (GDP). Much more important is the seven-month-old Section 301 investigation into China’s alleged infringement of intellectual property rights, the full results of which could be published as soon as next month.
Section 301 puts China’s critical hi-tech industries firmly in the cross hairs, and if the investigation identifies instances of state-led market-distorting efforts either to force, pressure or coerce US companies to disclose commercially sensitive technology, punishment – including restrictions on Chinese investments in the US – could follow.
Limiting Corporate China’s ability to expand in the US would directly challenge President Xi Jinping’s Made In China 2025 vision, which – among other things – relies on China’s tech giants to drive and innovate the new economy in the coming years.
To the extent that exposure to US innovation and earnings is considered essential to execute on the 2025 ambitions, an inability to expand in the US market is a clear roadblock and could possibly see tensions rise between China’s IT bosses and the president’s office.
All of this points to China having every reason to negotiate with the US and provide for greater access to its domestic markets. As such, expect China to grant greater access to selected markets for US companies, set in place agencies and monitoring systems to increase protection of US intellectual property rights, and step up commitments to buy more US-made goods to reduce the trade deficit.
But progress in resetting the US-Sino trade regime needs to be seen to be done, not least by the US electorate. A conciliatory China and headway on market access will provide a clear boost to the Republicans’ prospects in November’s midterm elections and indeed, Trump’s own re-election chances.
Inevitably, a fine balancing act is required. Trump cannot afford to provoke Beijing too obviously or by too much, especially with North Korea apparently seeking to come in from the cold.
Similarly, China is aware it needs to provide Trump with sufficient political face at home, or provoke a trade backlash with potentially worrisome economic consequences.
My overriding assumption is that sensible people tend to do sensible things; and that as such, sense will prevail.
Simultaneously I’m also aware the level of predictability falls sharply with less predictable people. The Trump administration has shown a good amount of sensibility on both the issues of exemptions to the steel tariffs, as well as the US-Korea Free Trade Agreement. But Trump has also brandished a radical streak, and Beijing seems to have taken note of it.
From our perspective, the more sensible bet would be on China and the US getting past these disagreements and coming to an arrangement that is more equitable, and therefore also more sustainable.
As such, the recent weakness in both Chinese and Korean equity markets simply increases the attraction that both already hold for us. Here, the radical might just be the more sensible: go against the grain and go overweight on both.
John Woods is the Chief Investment Officer, Asia-Pacific, at Credit Suisse