The ongoing trade quarrel between two major economies America and China has kept investors on edge since early last year. In July 2018, US President Donald Trump imposed tariffs on China for, in his words, unfair trade practices. Till now the US enforced a tariff of $250 billion worth of Chinese products and threatened tariffs of around $267 billion more.
As a retaliation to this, China set their own tariffs on US goods worth around $110 billion and was also threatening to undertake qualitative measures that would affect American businesses operating in China.
Many details still need to be worked out, including the terms of an enforcement mechanism to ensure that Beijing follows through on pledges to make changes to policies to better protect US intellectual property.
Some positive news reported by The Wall Street Journal stated that China would lower tariffs on American made goods including agricultural products, chemicals and cars in exchange for sanctions relief from the American capital.
Therefore the below are three scenarios that I believe can play out as negotiations are prolonged.
First and foremost, negotiations may fall out. Trump has been known to react unpredictably. He emphasised that the US could walk away from a trade deal if it were not good enough. Therefore the world should prepare for the worst case scenario. However, I do not think that Trump would risk the probability of creating a new global recession – as America and China are the world’s largest economies and are the centre of the global industrial supply chain.
High costs will continue to have a toll on companies’ operations which will create a chain of negative impacts starting from suppliers, manufacturers, retailers and at the end of the chain, the consumer. This means that the result of increase in prices will be derived from a decrease in production volumes, which in turn will diminish profit margins and drive companies to go bankrupt. Ultimately jobs can be lost.
Therefore I think that this scenario will not play out, as huge costs will exert pressure on both governments to back down.
Another scenario might be that if there is no deal that both parties are comfortable with, all can be reset and we will be back to square one.
This hypothetical scenario is based on the fact that both parties agree to talks and reach an agreement where trade flows resume as usual. If this scenario happens, business leaders in both countries will assess their future risk exposure as this will affect how business is done between the two and could also have an impact on how the world does business with China.
In times of heightened uncertainty a higher demand for lower risk products increases, which comes at the expense of sustaining lowering returns
China’s main income is derived from e-commerce done over the internet. Therefore the most to gain out of this trade war will be southeast Asia, as companies will seek to reduce their dependence on China’s supply chain and find an alternate solution to avoid any future reoccurrence.
Bloomberg reported that southeast Asia’s internet economy expanded by around 37 per cent in 2018 alone. This economy is on a fast track as the internet economy is being fuelled by 350 million users, and counting, online users, who are buying goods and services from across Asia. This results in $72 billion being spent within the economy which if it keeps increasing at the same pace, will reach $240 billion by 2025.
Overall this scenario is relatively more likely to happen than the previous one. However, I do not see this as a long-term solution, as the market, especially in the US, did not react well to the uncertainties that arose from this looming trade war.
On the other end, China may be affected by a slowdown in the manufacturing industry and the rise in unemployment. Both these factors will drive the Chinese to engage in talks with the US.
Second to none, a final outcome can be that China and the US strike a new trade deal with concessions negotiated on both parties. After coming to a truce, both governments will likely discuss the best way to get market access, securing intellectual property rights and cooperating to create a more level playing field for businesses in the private sector together. If this scenario becomes a reality, the deal would most probably include safeguards against any future trade arguments. This will also mean that the US could roll back tariffs on at least $200 billion in Chinese goods while China could remove or reduce industry-specific levies.
It’s true that it is the most ideal situation. However, I do not think it will happen in the near future. Having said that, if Trump manages to secure this deal, it would definitely be a feather in his cap for his campaign for a second term as President.
Till now Trump’s administration officials have said that they expect the two presidents to close a deal in coming weeks. However, as yet, no date has officially been set. According to a number of reliable websites, there has been progress and they are close to finalising this deal. However, the US Trade Representative, Robert Lighthizer, who has been leading talks for the US, warned that there are still major hurdles to overcome before closing an agreement. There is too much at risk from the negative economic factors and circumstances that can arise from a fallout, therefore its in their own interest to settle.
Overall, from this saga, an investor can expect swings in the value of investments. This can be seen in equity portfolios which are exposed to large international corporations that import and export to or from countries that are affected by the trade war.
Investors should ensure that their portfolio have an adequate hedge against such volatility by investing in uncorrelated assets such as alternatives, commodities or seeking corporations which are considered as staples in terms of their output.
Overall, all trade wars are about increasing the level of protectionism, and a trade war implies that less international trade is conducted, which adversely impacts global growth prospects and performance of growth assets such as equities.
In times of heightened uncertainty a higher demand for lower risk products increases, which comes at the expense of sustaining lowering returns.
This article was prepared by Matthew Miceli Donnelly, ICIWM, B.Com (Melit.), B.Com (Hons) Management, MBA (Melit.), an investment adviser at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The company is licensed to conduct investment services by the MFSA and is a member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or e-mail matthew.micelidonnelly@jesmondmizzi.com; http://www.jesmondmizzi.com .