Close Brothers Asset Management
In March, concern intensified that the US and China may be on the brink of a trade war, with US and global stocks declining, along with the US dollar.
Trump has long been vocal about tackling trade practices that do not protect US intellectual property (IP) and/or are viewed to have harmed production and employment.
While several countries have been cited as offenders, China – which accounts for over half of the US trade deficit – is squarely within his sights.
A recent US investigation under Section 301 of the Trade Act also found China to be the most significant violator of IP rights through practices such as forced technology transfer, licensing issues and piracy.
In seeking to become dominant in a range of technology areas as part of the Made in China 2025 initiative, the US also recognises that China is likely to be a more significant competitor in technology innovation in future, an area in which the US has historically believed that it has held a competitive advantage.
Trump, in moving to protect IP, is ostensibly protecting both current and future US profits. Clearly, an all-out trade war would be negative for global growth, inflation and for markets, including the US.
We believe that Trump knows that, and will not want to undermine the US stock market (indeed, he takes full credit for 2017 strength) or his ambitions for US growth after recent tax reforms. Our expectation is that current friction on trade is a ‘Trumpian’ negotiating tactic.
Our base case is not a trade war but continued trade friction that will likely result in a negotiated settlement. China, whose response has been proportionate, will look to play the long game here and not escalate tensions further. Comments on Sunday from US Treasury Secretary Steven Mnuchin reinforced this view – “We’re not afraid of a trade war, but that’s not our objective” he said. Beijing also appears willing to play ball, with trade liberalisation measures expected within six months.
Beijing is reported to be confident it can reduce the size of the US-China trade deficit, calm nerves on IP and give Trump what he needs to claim a victory in the upcoming US midterm elections. The measures so far have been more bluster than economic.
Since the Trump administration’s original parry on trade – a proposed metals tariff of 10-25% – he has shown willingness to water down the threat where expedient. The EU, Argentina, Australia, Brazil and Korea are now exempt from the metal tariffs, almost cutting the proportion of steel and aluminium imports affected in half.
These tariffs in themselves are extremely unlikely to have a material negative impact on the global economy. Like the metal tariff, the 25% tariff on Chinese imports is not material in economic terms: whilst it equates to roughly $15bn it is small fry in the context of the overall size of the Chinese economy.
To be taken more seriously is the accusation that China is using aggressive investment in the US to gain access to intellectual property, with Trump asking the US Treasury Department to develop plans to regulate China’s technology investments in the US. Since January 2016, US firms have accounted for around 20% of Chinese overseas M&A activity, three times the value of the next largest target country.
IP intensive industries, such as healthcare and technology, make up the bulk of acquisitions; these are sectors integral to China’s ambition to increase its domestic market share by 2025.
The US administration has identified tangible measures for negotiation and this gives us greater hope that a successful resolution can be achieved – these include opening up Chinese markets to overseas firms, reducing tariffs, and an end to aggressive IP practices. Such measures could help reduce the US trade deficit over time.
We expect the Chinese administration to also take a long view – the US is a large market for China and a source of technology China needs.
In terms of a timeline of events, the US Trade Representative will announce its proposed list of Chinese products to be affected within 15 days and allow for a 30 day comment period for industry, after which the tariffs kick in unless the US stops or delays the process.
Within the next 60 days, the Treasury Department will also craft new restrictions that would block Chinese companies from being able to invest in certain sectors of the US economy where it has sought to obtain US technology.
While trade frictions are likely to persist, we believe a resolution is possible. We think markets will remain nervous for a few weeks until the likelihood of a resolution becomes clearer.
However, the impact on global growth of the measures announced so far should be relatively moderate, unless protectionism increases and retaliation ensues. Should relations deteriorate, certain stocks could be affected more than others.
We are looking to identify vulnerable products, industries and companies, but also to find opportunities.
Some companies could benefit from restrictions, and we will be seeking specific areas in which one country may have a stronger position over another.