As the US-China trade war ramps up with a hike in levies, Tai Hui, chief market strategist for Asia-Pacific at JP Morgan Asset Management, tells Romil Patel where he identifies investment value.
Which asset classes and sectors in Asia are a sweet spot at present and why?
Given the context of the US-China trade tension at this point, I believe that in Asia, both equity and fixed income could appeal to global investors. For fixed income, a major difference between 2018 and 2019 with the trade tension as an overlay is that central bank policies are significantly different. The US Federal Reserve (Fed) is clearly content with the current level of interest rates. This time last year, China was focused on deleveraging, whereas now it is more about supporting growth – especially in the context of the trade war. This gives a very constructive backdrop for fixed income.
On the equities side, let’s start with income, because there is more volatility in stock markets and income is a more consistent provider of return. There are lots of high-income, high-dividend opportunities in this part of the world.
Secondly, if investors are worried about trade tensions right now, who could be a little less sensitive – or even benefit from trade tensions? This is where south-east Asia and India come into play. Looking at the next three years, I am more than happy to bring north-east Asia back into the fold but given the current context, I am pushing towards south-east Asia and India. A lot of companies are considering relocating to Vietnam, Indonesia, Sri Lanka or Bangladesh and frankly, the trade war is a catalyst. Even before that, multinationals and Chinese companies had started migrating some production capabilities to other parts of Asia as China was getting more expensive.
The sweet spots right now are fixed income, whether it is with government or selected corporates in Asia. In equities, it is about trying to factor in a little bit of protection against the trade tension, which will continue – and that is where south-east Asia has been more resilient and much lower down the impact zone.
China was already moving away from being the global factory floor, but the trade tension has accelerated the reallocation of capacity to other Asian countries. Are there any pockets of the continent that concern you from an investment perspective?
It is the flip side, it is north-east Asia. The US-China trade tension will put pressure on Taiwanese and South Korean companies, partly because they are very much an integral part of the Asian supply chain. We are also going through an electronic downcycle – there has been a slowdown in demand for mobile phones, whether it is because people are waiting for 5G technology to come through or simply because the growth progression in mobile phones has started to plateau, so the upgrade cycle is getting longer, and demand has come down.
At the height of trade tensions between November 2018 and April, different asset classes behaved in a variety of ways. Following the latest cycle of hikes, what are you expecting this time?
So far, we have seen a very similar pattern, but the magnitude of correction has not been as severe as last time, partly because it was a fresh shock then. This time, people have done their homework and know the net economic impact is still manageable.
The big question is around business sentiment, and that will take time to reflect. The policy backdrop has gone from Fed normalising to Fed pausing and we may even be close to the peak of this cycle. The People’s Bank of China (PBOC) is adopting a pro-growth stance and Asian central banks such as in the Philippines, Malaysia and New Zealand cut rates. We are going back to 2017 where there is no alternative – cash is not a particularly worthy investment. Across Asia you are getting very little return from cash and that will create demand for fixed income.
On May 10, 2019, the US hiked levies on $200 billion (€176 billion) worth of Chinese goods to 25% (from 10%). What impact will a more protracted trade war have on both nations, as well as the global economy?
The bigger threat is how it impacts on corporate sentiment. The ups and downs in the relationship make businesses uncomfortable, and investment and capex plans could potentially be postponed or delayed. We may see companies planning new capacity in parts of the world other than China, so there may be an investment cycle, but overall, we are in a world where the amount of stimulus that central banks and governments in the West can provide is becoming increasingly limited.
The same is true of China. In terms of the impact on trade, consumers in the US can absorb a lot of the costs, but business uncertainty is the bigger threat.
The latest hike in tariffs affects a range of Chinese electronics, from internet modems to routers and printed circuit boards. If technology is the basis of the trade war, why would China cede any ground to the US in this regard?
This is why the trade negotiation has been so challenging – because what the US wants in industry policy changes and developments in technology, China thinks is their right to develop. This is where China is very mindful of not yielding, but at the same time, there are a lot of products and services that it needs from the US, so they do not want to burn those bridges and it makes China want to negotiate and reach an agreement.
The truth is that two economies are so intertwined right now that a trade war that severs any link will be damaging for both sides and China and the US see this. But in many ways, the US has a stronger hand in that it must still buy things from China, that is very competitively priced, but over the next three to five years, that could shift elsewhere – south-east Asia, Latin America, central/eastern Europe. On the other hand, China needs US chips, services and software. They could develop them, but the US has such a lead and there are few alternatives that China can source from – that is why the Americans feel they have the upper hand in the negotiation.
The US president said Washington would begin “paperwork” to apply a 25% rate on other Chinese imports, worth $325 billion. How could this make matters go from bad to worse from an investment perspective?
The response from China will be important. Given the U-turn we have seen recently, there is a growing sentiment that the remaining part of Chinese exports could be taxed. At the end of March, that seemed unlikely, but there could be a 40% to 50% probability now. What does that mean for US consumers?
There are areas where the US will have no alternative but to buy Chinese exports, for example rare earths, where China is so dominant. The remaining part of Chinese exports will cover that unless some US companies apply for an exemption, so there are still ways out and holes that be poked to limit the impact. Assuming that everything under the sun will be taxed, the damage to the US economy may well be more apparent than what we have seen so far.
Ultimately, both sides are going to pay. Some will be more headline-grabbing, like the farming sector, to limit the damage from a political standpoint. In China it is less of those headlines, but the government is providing more support to the economy. The politics and the appearance are easier to manage, but China does not have an election to run next year. Public opinion in China is also important and that is why there have been more comments from Chinese authorities to gather public support. While Beijing does not have to fight for re-election anytime soon, they also need to gather support from the public to have that mandate to push back on US demands.
Should investors be exercising greater risk control with the uncertainty?
Yes, but not just because of the US-China trade tension. We have seen the global growth cycle on track for almost ten years and frankly, it is not easy to find cheap assets. On that basis, plus the US-China trade tension and populism on the rise in other parts of the world, we recommend our clients to be agile and adjust allocations, income generation and resilience.
We think more about volatility management rather than what kind of returns we want to generate. In the long run they are interconnected, but in the short-term it is about risk tolerance and allocating accordingly. It is something that we have been advocating over the last couple of years and the trade war merely reinforced that point.
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