In light of these trends, we think there are five strategies for investors to consider that can either help take advantage of emerging opportunities or protect against the downsideIn light of these trends.

U.S.-China tensions have dramatically increased in recent weeks. After the August 6 executive orders on Tiktok and Wechat, the US Department of Commerce further tightened the export ban on Huawei on August 17. The tech war escalation is leaving investors wondering about the potential economic and market impacts. We’ve pointed out in recent notes that economic growth has largely been unaffected, at least so far, as the bilateral trade relationship has been spared from the recent tit-for-tat. China’s July export data, released by the Customs office, shows that U.S. imports from China are growing at the fastest pace in nearly two years. The recent positive tone from the “phase one” trade deal review likely affirms that the deal will hold.

Nonetheless, recent actions, particularly a tightening of export controls on sales to Huawei, have created further uncertainty. It is exacerbating concerns of a bifurcated tech ecosystem. With the U.S. and China looking like they are diverging further on technologies, investors have been left to wonder if the world is truly headed for technological decoupling. It’s hard to argue the process isn’t already underway—the process of securing critical tech infrastructure, limiting foreign hardware and software, and creating separate internet ecosystems has been ongoing for over a decade. But clearly, bigger barriers are being put in place…and at a more rapid pace than before.

As events are still unfolding, with potentially wide-ranging implications, it’s difficult to quantify the exact macro impact at this stage. But one implication that’s already quite clear is that ultimately the global economy stands to lose from this technological decoupling. The theory of comparative advantage suggests that if supply chains or production are duplicated and reproduced for reasons other than economic efficiencies, the result could be less globally efficient. Depending on what each participating economy brings to the table, the cost will also look different. For economies whose competitive advantage is R&D, the cost of decoupling is slower innovation. For economies that specialize in high-end manufacturing, the cost is smaller economies of scale. For consumers, it means a higher cost for the same product. And finally, a broader point is that for ‘catch-up’ economies, duplication is generally not an optimal way to allocate resources. It is for this reason that developing economies that have ‘caught up’ more successfully were generally more open to global trade.

The real world is of course not so simplistic. Security concerns can trump the argument for economic efficiencies. As geopolitical concerns increasingly influence economic decisions, the downside from tech decoupling will likely be felt more broadly.

This creates an environment where structural shifts bring new opportunities for investors, but one with an overhang of macro uncertainty. In light of these trends, we think there are five strategies for investors to consider that can either help take advantage of emerging opportunities or protect against the downside:

1. Economies and businesses that benefit from supply chain redirection. Throughout the trade war in 2019, U.S. imports from China fell while its imports from other areas of EM, such as Vietnam and Taiwan increased (according to 2019 annual data from respective custom offices). There are relative winners and losers, and economies that benefit from increased FDI and a larger export market share could outperform.

2. Trend of localization. Decoupling means an increased domestic focus within China and the U.S. This creates local beneficiaries—although, as we argued before, at the cost of global efficiency. In particular, China will likely push for a faster development of domestic technologies, such as semiconductors, in order to mitigate risks to its increasingly important tech sector.  However, the shift towards locally-produced goods and domestic brands is not just in tech. The chart below highlights the substantial shift towards domestic excavator brands over the last ten years with local companies now making up nearly 70% of domestic sales.  

3. Businesses that innovate. Great power competitions, such as during the Cold War, or the early part of the 20th century with Germany and the U.K., resulted in periods of dramatic innovation. Large increases in state-led investment, R&D, and spending, led to increased innovation. Companies at the cutting edge of technology are likely to receive policy support and benefit from long-term structural growth. In particular, we think defense tech and cybersecurity are themes that can provide some stability for portfolios amidst volatility.

4. Structured products: Volatility is here to stay, with a combustible mix of rising U.S.-China tensions and the uncertain path of COVID-19. Structured products and derivatives can help you use volatility to your advantage by providing increased exposure to the upside alongside limited exposure to the downside.

5. Adding traditional hedges. Traditional hedges, such as precious metals, are still useful. Gold rallied significantly on the back of rising trade tensions and the COVID crisis. We still think the yellow metal can provide an important diversifier to portfolios, but we’d recommend being thoughtful about how you gain exposure. 

The tech war has intensified over the last few weeks. This is leaving investors wondering about the potential macro and market impact. Given events are still unfolding quickly, with potentially wide-ranging implications, it’s hard to precisely quantify the macro impact at this point. But the economic theories underpinning global trade suggest that everyone stands to lose when resources are used for duplication, instead of innovation. As geopolitical concerns increasingly trump the arguments for economic efficiencies, the downside to the global economy will increasingly be felt.  

All market and economic data as of August 31, 2020 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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