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The news of a trade truce between China and the US was welcomed by markets and economists alike, prompting estimates of economic growth and corporate earnings to be marked up as a result. While the impact of the coronavirus may now delay a growth recovery, and the ‘deal’ lacks detail, any improvement in trading relations between the US and China, no matter how limited, will probably be deemed as positive for the longer term.
In my view, such a belief is premature. Tensions between the two global powers are not going away. Investors should be prepared, not for greater convergence, but for a growing chasm between the US and China with meaningful consequences for allocations and returns.
Tariffs have had less of an impact on overall economic activity than was initially feared, due to counterbalancing fiscal and monetary stimulus in both countries and China’s economy switching towards services and away from manufacturing. Therefore, their removal may not boost growth as much as many believe. But the resulting changes in supply chains triggered by the tariffs are emblematic of several ways in which the US and China are pulling apart.
First, economic policy may become increasingly divergent between the US and China. The US and broader asset markets were buoyed in 2019 by the US Federal Reserve reversing its prior path of tightening monetary policy. This was driven by concerns about liquidity in funding markets, some soft economic data and, most significantly, substantial and vocal political pressure.
Despite an ambition to unwind these measures, the US is in an election year and President Trump’s focus is on both the domestic economy and the performance of the S&P 500. As a result, Fed Chairman Jerome Powell will face pressure to keep monetary policy loose.
This contrasts with China, where the leadership has accepted a lower level of headline economic growth than seen in past years. While we expect supportive fiscal policy and limited rate action, especially in the wake of the coronavirus, there is little appetite among China’s policymakers to follow the other major economies towards low and negative rates, citing the risk that they pose to sustainable economic growth.
Similarly concerns around the relative strength of the US dollar has been a source of anxiety for US government, whereas China seems more motivated to see the Renminbi develop its status as a stable alternative reserve currency. That means the recent softness of the dollar relative to the RMB may have much further to go.
Second, the next phase of development for dominant technology platforms may bring further divergence. In the US, large technology companies have evolved at such exponential rates that regulations have understandably taken time to catch up.
It is likely that in the next decade, almost by dint of their monopolistic position, regulation around use of personal data and accountability for user-generated content could increase in a substantive way. This is something that investors need to be wary of and is arguably not reflected in current valuations. This could also occur at a time when, in some cases, customer bases are not growing at the same rate and in some cases are dwindling. If we do see a de-rating of these companies in the US, there is a risk that Chinese equivalents, such as Tencent and Alibaba, are impacted from a sentiment point of view.
It is unlikely, however, that such a clampdown will take place in China. Beyond the clear differences in societal attitudes to data privacy, large Chinese companies, state-owned or privately-owned, have governance structures that ensure that they are aligned and responsive to Party interests.
In that context, the large technology and e-commerce platforms in China have considered their social licence as they have developed their business. A good example of this would be Tencent regulating the gaming time available to younger users following concerns about impact on eye health in children.
An ambition to create new national champions could lead to a fundamentally different backdrop for the next phase of development of the ‘Tech Mega-Caps’ in China versus the US.
Finally, we could also be starting to see a divergence in terms of the balance of priorities between domestic policy and international development.
China continues to push the Belt and Road Initiative (BRI) as the cornerstone of its strategy for international engagement and economic partnership. The experience of the trade war with the US (which had as much to do with domestic politics as terms of trade) appears to have given a lift to the BRI, resulting in a year-on-year growth in new contracts signed across Asia and other developing economies globally. It is interesting to see delayed or abandoned rail projects in South East Asia start up again.
This brings us to the outlook for the RMB and why a stable currency is as much, if not more of, an imperative for the People’s Bank of China than a ‘competitive devaluation’. At the same time, it feels that the same motivations around promoting domestic US interests continue to drive the White House (unsurprising in an election year) and, as the trade war with China takes a pause, a new front with Europe appears to be opening up.
It may be the case, therefore, that investors should not overplay constructive trade talks between the US and China, in terms of the impact on the outlook for demand and for corporate earnings growth.
More importantly, it should be seen in light of a broader ongoing divergence in terms of economic strategy and development that will have meaningful consequences for leadership within markets.