Just a little over a year ago, trade war news dominated media headlines and rocked global financial markets. Then in 2020, an unexpected pandemic overturned the world both socially and economically.
Since early last year, trade issues have taken a back seat to the global health crisis while countries entered unprecedented lockdowns and enforced severe mobility restrictions. Almost a half year into 2021, as developed economies gain ground on inoculation against the novel coronavirus, many regions are looking to reopen their borders and revive their economies.
Now, with some light at the end of the healthcare-crisis tunnel, governments around the world have begun revisiting their trade policies. Front and centre is the ongoing geopolitical tension between the US and China, the world’s largest two economies, and its implications for financial markets and the global economy.
During his four years of presidency, Donald Trump shocked the world by invoking a series of extreme populist policies. As Trump pulled the US out of established world organisations, took a hard stance on immigration, and imposed tariffs on allies and competing countries, investors pondered whether the world was entering an era of de-globalisation.
Then five months after President Joe Biden took office this year, the Democratic Party leader has once again changed the America’s course on climate, taxes and relations with long-term allies.
However, the tension between the US and China has not eased that much. For example, an average 19.3% tariff continues to be imposed on US$370 billion of annual imports from China, which is equivalent to three-quarters of total Chinese exports to the US.
Despite all of these legacy tariffs still being maintained, manufacturing has not really been shifted to the US, but to other countries with cheaper labour such as India and Vietnam. As well, costs are being passed on to US consumers through higher prices. Some argue that removing tariffs now could provide a timely hedge against overheated inflation, but the US government still needs tariffs as a bargaining tool to negotiate geopolitical issues.
As China’s economy continues to grow at a faster pace than the US, the power battle does not look like it will end any time soon. On the other hand, we could see a deal on the trade front given how much both sides have to gain (and lose). China was the America’s largest trading partner in 2020. In fact, US exports to all its major trading partners declined last year with the exception of China, where they rose by about 10%.
On the other side of the equation, China’s exports to the US in Q1 rose 62.7%, while imports from the US increased by 57.9%. Imports mostly increased in agricultural products, autos and auto parts, and energy. Despite the disagreements, trade between the two countries is mutually beneficial.
Back in 2015, Chinese premier Li Keqiang issued the ‘Made in China 2025’ initiative, a national strategic plan aimed at transitioning China away from being a labour-intensive world factory towards a high technology powerhouse. Chinese leaders hope that large amounts of government investments in key technologies will secure the country a lead position in the Fourth Industrial Revolution. The initiative is designed to capture global market share in sectors from artificial intelligence, 5G cellular telecommunications, aerospace, semiconductors, and electric vehicles to biotech.
To enhance its global leader position, the US government has been working on the US Innovation and Competition Act. On 8 June, the bipartisan US Senate passed the sweeping competition bill aimed to improve the country’s global competitiveness, especially its ability to compete against China. This legislation still needs to be approved by the House of Representatives before being signed into law by the president.
As the largest investment in technological innovation in generations, the new package includes about $190 billion of funding to strengthen technology and research, in addition to $54 billion to increase production and research into semiconductors and telecommunications equipment. The bill also seeks to increase US involvement in international organisations in order to counter China’s growing global influence.
Despite US sanctions on Chinese companies and ban on a number of Chinese stocks, offshore investors have been steadily increasing their exposure to the Chinese market with foreign fund inflows into Chinese stocks rising rapidly in the past few months.
For example, China A-shares, once very difficult for non-Chinese to access, have become more mainstream. During their 2019 semi-annual index review MSCI, a leading index provider, announced it would increase its China A large cap share weighting from 5% to 20% in the emerging market index and other relevant indices. Additionally, the MSCI planned to add 168 China A mid-cap shares at a 20% inclusion factor.
As the global healthcare crisis fades and vaccines made more widely available, investors must once again keep an eye on trade and how it could again become a major factor influencing markets.
While we may be a long way from a Cold War detente, there are reasons for optimism. Overall, we remain constructive on emerging markets including China and continue to favour previously embattled technology sectors, such as semiconductors, on a selective basis.
Nan Wang, CFA is a portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact the Cayman office of LOM at (345) 233-0100 for further information.