China-US trade deal: what should investors expect?

March 21, 2019 12:31
US and Chinese officials pose for a photograph before the start of another round of trade talks at the White House in Washington on Feb. 21. Photo: Reuters

The American and Chinese trade delegations have been conducting intensive talks to try to reach a deal acceptable to both sides. Progress reports have been positive as US President Donald Trump recently postponed imposing a 25 percent tariff on US$200 billion worth of Chinese imports. Both sides will reportedly keep working to reach an agreement before a possible end-of-March meeting between the two nations.

While it is true that China’s alleged trade malpractices are at the core of the negotiations, there is, in fact, a range of individual issues on the table. We think China will fix some trade malpractice allegations to resolve its trade dispute with the United States, and that China may gain long-term benefits by yielding some grounds by strengthening intellectual property protection and ceasing forced transfer of technology.

While it is hard for China to admit its wrongdoings such as cases of cyber-theft and non-tariff barriers, if China makes concessions on these points, both nations could halt these covert operations. Regarding “Made in China 2025”, China is neither likely to change its long-term strategy nor curb government subsidies, as China still has a state-led economy and is committed to transforming it to grow out of the middle-income trap.

Whatever the outcome, we believe a partial or comprehensive deal would be received favorably by risk markets globally. The trade wars have been a dark cloud over the global economy and have created uncertainty around trade, corporate spending and supply-chain management. If China and the US are able to reach an agreement, this overhang would be lifted to some degree.

Perhaps, we could even enter a more open environment for global trade and China’s markets. In this scenario, both US and Chinese equities could respond well, the renminbi might strengthen and the US dollar could stabilize. Emerging markets and international equities could also benefit from an overall risk-on environment.

Nevertheless, as we get closer to an actual deal, it will likely continue to get “priced in”. While a deal carries some potential upside, investors should note the extent to which this outcome has already been factored in by the markets. Equity markets in the US and China have already done quite well this year. Any further upside may come when the markets see signals that growth has stabilized – not just in the US and China, but also globally.

We think investors should continue to invest in sectors such as technology, industrials and energy/materials. They should benefit not only from lower tariffs, but also from prospects for enhanced global growth. Globally, we continue to favor our broader “barbell” approach in equities and fixed income across multiple regions. The US remains an economic relative outperformer among developed market peers, while China and select emerging markets should benefit not only from a trade deal, but also from an ongoing Chinese stimulus, a potentially stable or softer US dollar, and more attractive valuations.

But even if trade-related uncertainties were to be lifted, investors would still face a late-cycle backdrop of slowing global economic growth and increasing accommodation from central banks. In this environment, risk assets may perform well, but with higher levels of volatility and greater dispersion between the winners and losers.

Investors should actively invest across asset classes – equities, fixed income and alternatives – to identify winners and losers, generate potential alpha and help manage risks. With lower rates and generally low inflation globally, the biggest risk may be to avoid taking risks. Investors should consider maintaining exposure to risk assets to help meet income and return targets, and to help guard against wealth erosion over time.

Lastly, investors can seek more active downside protection, perhaps by incorporating environmental, social and governance (ESG) factors as an additional risk-management tool.

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As Global Strategist at Allianz Global Investors, Neil Dwane is responsible for presenting strategic house views and overseeing the Economics and Strategy Research teams.