Cooling overblown expectations

Cooling overblown expectations

by Pininvest Analysis

Exposure to US-China Trade on

  • 37 constituents
  • 36.1% 1y performance
  • 38.8% volatility
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US-China trade deals are expected to be announced shortly, in flattering light and with much flag-waving on both sides of the table

Primed for the pitch, financial markets will respond positively but...the run may be short-lived 

Only what the agreement does - and what it does not - spell out - in precise (and enforceable) wording, will matter

The current trade differences could turn out to be the skirmishes of a costly, drawn-out conflict




Although China and the US are tempering their trade differences, it remains difficult to evaluate the fall-out for the manufacturing sector

Technology stands out in US-China trade relations today, and will remain so for years to come

  • entire industries are geared up on the Chinese supply chain (Apple comes to mind…),
  • major US semiconductor groups depend on the revenue generated in China (Intel, Qualcomm...)
  • and semiconductor equipment specialists rely on the only growth market worldwide, powered by the ambitious planning of Chinese upstarts to secure domestic chip supply

If, as has been suggested lately, the negotiations center on Chinese imports of agricultural products and energy and the repeal of the until now obligatory domestic partnerships for US companies (within 3 years), it will have been much ado about … very little


US-China trade negotiations - Credit White House

Only what the agreement does - and what it does not - spell out - in precise (and enforceable) wording, will matter

  • State and provincial subsidies, financial stakes by private firms and loans by State banks are supporting the key industries of China’s industrial medium-term plans – presumably, this fundamental issue will remain untouched
  • R&D partnerships have already been fully implemented over the years (in car manufacturing as well as in semi-conductor design, in pharmaceuticals etc.) and can hardly be expected to wither – any flexibility on technology sharing requirements will play to the gallery and in practice, there are so many ways to fall back on … as the US Trade Representation spells out in the Section 301 report update of November '18…(from page 22)
  • Relaxation of the rules on foreign ownership in financial services, announced in November ’17, and reviewed by KPMG in a March '18 report, remain a ‘work in progress’… and the foreign institutions may be forgiven to entertain a modicum of doubt about the benefit they may ultimately derive
  • Concerns regarding exchange rate manipulations are a perennial bugbear of the American authorities and any commitment to a fixed (or semi-fixed) Yuan / US dollar rate would be very carefully worded, remaining improbable beyond the short term. To go any further would be an unreasonable infringement on monetary sovereignty, as the Chinese negotiators have undoubtedly signaled
  • Cyber-attacks on Western companies, never fully acknowledged although Chinese authorities have been confronted with the facts, can be expected to continue unabated. Recent official US statements by Director of the National Economic Council Kudlow confuse forced technology transfer, fully assumed by China and at the center of discussions, with intellectual property theft and cyber hacking, which probably remain off limits, leaving any resolution unclear and hardly encouraging


In sum, there is no credible ground for resolving the fundamental differences between the two great world powers, and there never was…

The current trade differences hardly have the make-up of a ‘war’ – they are just skirmishes in what could become a costly, drawn-out conflict

Leaving posturing aside, the negotiators will probably attempt to agree on rules to manage, and contain, the confrontations to come – a cold war of sorts

But the American administration should not leave in doubt that open markets do not give any country a license to free access without counterparty


Thriving on the "socialist market economy"

When the two largest economies on the planet operate under very different rules, disagreement is preordained …

Shanghai skyline, Lujiazui financial district of Pudong, credit S. Desmarais

China has sought to strike a balance, by qualifying simultaneously as

  • a command economy where central planning assigns investment priorities in sectors deemed to be critical for further expansion – with robotics, artificial intelligence, semi-conductors, renewables and electrical vehicles and cell therapies in the line of sight
  • a mixed economy associating foreign firms, willing participants, and beneficiaries, of expanding markets; partnerships in car manufacturing, a modle honed over decades, has been rolled out across the industrial sector
  • an (almost) free market powering domestic consumption with e-commerce or video gaming at the forefront… until the firms are brought to heel (as Tencent and Alibaba are discovering)

Considering their achievements over the past decades and feeling smug, the Chinese authorities can hardly be expected to support is an overhaul leveling the playing field and giving a free(er) hand to foreign firms – it will not happen

It stands to reason that China will double down on ambitious agendas

  • with a focus on developing its domestic market, China’s industrial policy should earn plaudits
  • the country’s success in lifting millions of its citizens out of poverty should continue to be widely recognized

But ...


Overplaying one’s hand

Photo by Alessandro Bogliari on Unsplash

Avowed mercantilist policies, feeding on unquenchable consumer demand in Western economies, have been the engine of Chinese growth since introduction of economic reforms in the early 1980’s

With the WTO entry in 2001, Chinese manufacturing double down on the policy, entering new industry segments seemingly overnight, with production capacities overpowering established Western suppliers time and again

Confronted by its trading partners with piecemeal objections about side-tracked WTO commitments, China’s authorities misinterpreted the weak Western push-back for implicit acquiescence

Assuming, rightfully, that there was much to gain for Western industry in China, and for Western consumers – and much to lose in terms of growth and buying power from constraining Chinese trade – China felt confident unbridled expansion was within reach

This is, in our view, the reason why export kept precedence over domestic consumer demand – which remains nascent beyond tier 1 and tier 2 cities – a policy dovetailing neatly with the country's geopolitical ambitions

As exporting powerhouse asserting its dominance in world-class industries, China appears to be scaling its position of indispensable partner to a seat at the head of the table

With free international market access unequivocally the ace in a high stake game, the US negotiators are expected to hold back on a definitive 'peace' and they should not be alone, with the European Union coming to terms with the new realities of global trade

A truce will be welcomed, and rightly so, but, as we hope to discuss in our follow-up report, Western technology must get its act together