It has been less than a month since I came back from meeting clients in Hong Kong and Singapore. The mood I encountered there was one of caution, with talk about the future path of the US dollar and interest rates dominating discussions.
To my surprise, there was limited debate on the escalating conflict between China and the United States. While the US midterm elections did come up in the conversations, there was a general expectation that Republican losses, in particular, the loss of control of the House of Representatives, could see the Trump administration easing off on its almost daily attacks on China.
I am of a different view. What started as a campaign pledge to reduce the US trade deficit with China has developed into something far larger: accusations of intellectual property theft, unfair restrictions on US companies operating in Chinese markets, human rights violations, “debt diplomacy” (extending excessive credit to another country and then extracting economic or political concessions when they are unable to meet the payments) and allegations of election meddling.
If there was any doubt about US intentions, we just need to go back to Vice President Mike Pence’s speech on October 4th at the Hudson Institute denouncing China. Some experts say this speech marks the biggest shift in US-China relations since Henry Kissinger’s 1971 visit to Beijing and even the beginning of the second Cold War.
Unfortunately, Trump has a broad authority to impose restrictions over trade and investments based on national security concerns with limited checks from Congress, so it would be no surprise if he continues to go down this road for the foreseeable future.
This conflict could not have come at a more difficult time for China. The latest PMI data showed manufacturing growth in September slowing to its lowest level in more than two years. While we are not of the camp that believes China will face a hard landing even under these conditions, investors should come to the realization that the size of the country’s economy and the point we are in in the economic cycle mean the Chinese authorities will have a difficult time achieving their target growth rate of “around 6.5 percent” for 2018 and 2019.
The action taken by the government so far to loosen fiscal and monetary policies is a sign that they expect a long-drawn-out confrontation with the US and are formulating different plans to stimulate the economy amid the possible loss of growth from the escalating conflict while maintaining their long-term goals of deleveraging and financial risk control.
We need to monitor very closely how these policies will play out as it is a very difficult balance to achieve. Unless growth comes under significant pressure, we don’t expect to see a repeat of the magnitude of the stimulus during 2015-2016 or a competitive devaluation of the yuan.
Earlier this month President Xi Jinping used an international trade conference to announce several new policies designed to boost confidence in the country, including accelerating the liberalization of the telecoms and education sectors and encouraging imports by reducing import tariffs and strengthening intellectual property protection. Such measures are key in these troubled times.
Markets remain sensitive to any pronouncements from US officials on a possible resolution to the current trade conflict between the two nations. Only last week, conflicting signals from US President Donald Trump and Larry Kudlow, his chief economic adviser, on the prospect of a trade deal between China and the US had markets being pulled one way, then the next. Both Xi and Trump will meet at the end of November at the G20 meeting in Argentina, but my base case scenario continues to be that no major breakthrough will come during this junction.
For the rest of the year and the start of 2019, we choose to remain cautious. We expect the US dollar to continue to strengthen in the short term, but then to level off in the first half of 2019 as economic growth cools – the housing market and auto sales are already signaling a slowdown may be on its way.
China-US headlines (or tweets) will continue to create noise and unfortunately, volatility is here to stay. At the same time, the situation has also created attractive entry points for those investors that have done their homework.
Differentiation in emerging markets is key to successfully navigating a more challenging environment.
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