Ask CIO: Can China ride the trade-war storm?

"Tug of War" market to stay as the US-China trade conflict has morphed into a fight for global strategic and technological dominance. Such structural issues will take a longer time to resolve.
Chief Investment Office10 May 2019
Photo credit: AFP Photo

What happened?

US raised tariffs on USD200b of Chinese goods; China vowed retaliation. The calm in financial markets did not last, after all. For months, investors have been pricing in an eventual resolution to the ongoing trade spate between the US and China, but awakened only to the crude reality that the chance of a resolution remains elusive.

To recap, US President Trump’s tweet over the weekend threatening to raise tariffs has triggered a broad-based selldown in global markets, with the S&P 500 and Hang Seng China Enterprises Index (HSCEI) down 2.5% and 6.3%, respectively (as of Thursday, 9 May). And true to form, the US hiked tariffs from 10% to 25% on USD200b worth of Chinese imports on 10 May. China said it will take counter-measures without providing further details.

What does this mean?

Trade tension no longer about “trade”; the “tug-of-war” environment set to stay. The Chicago Board Option Exchange Volatility Index (VIX) has spiked 48% this week (ending 10 May) – a timely reminder that volatility is set to stay. There are no winners should this trade spat persist. This is evident from recent macro data, which saw global trade volume plunging 1.4% y/y in December 2018 (Figure 1), and US exports to China falling 18.8% in 1Q19 (Figure 2).

In any case, should the US and China manage to reach a trade resolution, calm will resume in financial markets. But this will likely be transitory given the key issue here is no longer trade, but global strategic and technological dominance.

Such things will not be resolved overnight and undercurrents will continue to linger in the foreseeable future.

China possesses ample policy room to weather through the storm. Investors often ask: how will the trade war affect China?

Clearly, the ongoing trade spate has weighed on China’s external demand – the country’s first quarter exports to the US declined 9.0% (Figure 3). However, despite the macro headwinds, we believe that China possesses ample policy room to support the domestic economy and ride through the storm.

The recent reserve requirement ratio (RRR) cuts is a case in point. Historical data suggest that RRR cuts in China lead to stronger domestic economic activity.

Meanwhile, on the sectoral front, China Financials and Technology remain in good shape:

  1. China Financials: China banks act as important liquidity providers against external uncertainties. With at loan-to-deposit (L/D) ratio at 75%, there remains ample room for further monetary easing. Asset quality, meanwhile, has improved as suggested by the falling non-performing loans (NPL) ratios (Figure 4) among large banks and near-200% of NPL provision. All these point toward a healthy stance in the sector.
  2. China Technology: Despite concerns on how the trade war may negatively impact the Chinese technology sector, China is spreading its wings in this space by:
    1. Narrowing the gap of patenting. China’s number of patents in force went above 2m (Figure 5) and its new patents filed have surpassed that of the US since 2012.
    2. The great advancement in 5G networks – technology that is strategic to development in big-data, artificial intelligence, e-Commerce, Internet-of-Things (IoT), Industry 4.0, and technology supply chain. A successful global adoption of China’s 5G network will elevate the country’s position in technological innovation.

What should you do?

Focus on fundamentals; Stay invested using Barbell Strategy. The recent pullback in financial markets may have a sense of déjà vu – back in 2018, risk assets had similarly whipsawed on trade concerns, only to recoup its losses on the back of improving corporate fundamentals.

This time around will be no different.

Beyond the current bout of profit taking, we expect investors to return to equity markets as corporate fundamentals remain sound and valuations are not excessive. Investors are advised to adopt a Barbell Strategy and stay invested.

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