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Long awaited détente in US China relations reduces recessionary risks

Market Update
zhang_jin

Jin Zhang

Portfolio Manager, Senior Research Analyst

Investors are taking a breather. Over the weekend, the US and China agreed on working out an interim deal which could be a first step towards ending a protracted and economically harmful trade dispute. It is a comprehensive agreement, covering a wide range of issues including the protection of intellectual property and the opening of China’s financial services sector. It is still tentative and incomplete, but I won’t dismiss its significance. Although there are still a lot of uncertainties, I am hopeful that the agreement will be formalized soon and will last. Much depends on whether the agreements of phase one will stand when phase two is not making progress in the future. Since both countries have a lot at stake, they probably will. It is in their own interest to reach a formal agreement in the next few weeks, as opposed to letting the relationship deteriorate in an uncontrolled fashion.

Trade war risk lingers on

Although downside risk is reduced by the deal, the trade war is not over. There still is risk of re-escalation. What happens to the tariff hike scheduled for December is undecided. However, at least both sides recognize there are gains in reaching an agreement. China needs its external environment to stabilize. For the US, the deal not only reduces the risk of recession down the road but also opens up markets of potentially very large size. The rest of the trade talk is likely to drag out without much progress, but that is widely recognized by the market and unlikely to derail what was agreed upon in “phase one”.

US financial sector to benefit – tech war continues

Other than US agriculture, the financial sector stands to benefit the most from the opening up of the Chinese market. The financial market in China is almost as big as the one in the US and represents a significant opportunity for growth for US companies. US financial companies have good reputation in general, and some of them already have good brand recognition in China. They stand to gain meaningfully after the deal closes.

The tech sector is still in limbo. The Huawei issue was “separate” from the trade agreement and I doubt there will be any break-through in the near future. Even in the longer term, there will be significant fissure.  Not all companies are affected equally though. Some, like Taiwan Semiconductor Manufacturing Co. (TSMC), should be able to perform well in a world of uncertainties. But it is important to recognize that the “tech war” is ongoing and the underlying issue can’t really be resolved.

Agreement provides uplift to economic sentiment

Although the cyclical pressure in many parts of the world is still high, the agreement helps to stem the sliding to the downside in both the Chinese and the US economy. The agreement is wide-ranging. Reaching such an agreement reduces uncertainties in the world. The market will take time to appreciate its positive impact. Europe should benefit too from the reduction of downside risk. Emerging market economies should feel relieved that the downside to the renminbi is officially restrained as part of the Chinese commitment. 

For growth to bounce back, real economy needs to reassess risks

There still is pressure on the central banks to ease, but they cannot save the world economy alone. They need companies and households in the real economy to reassess risks, before growth can be resumed. The trade agreement reduces downside risk, which is a prerequisite for many businesses to start investing again. Investors preferring companies with real competitive advantages that can prosper even when there are many uncertainties are likely to fare better than those who rely on the central banks’ liquidity tap.



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