This year’s G20 Summit has captured significant attention from markets.
In past years, G7 and G20 summits haven’t had deep market implications, but given the context of the recent US-China trade disputes, the meeting of Presidents Xi and Trump in Argentina has been very closely watched.
During our latest client call, Alex Wolf, Head of Investment Strategy for Asia at J.P. Morgan Private Bank, and Paul Thompson, Head of Investments for Hong Kong and Philippines, discussed the market implications of the G20 meetings.
- Both the US and China have shown willingness to be flexible and offer concessions
- The US agreed to postpone a raise in the tariff rate from 10% to 25%, which was meant to come into effect on January 1, 20191
- Tariffs do not benefit either side of the relationship
- The trade deficit and competition around technology remain significant structural issues
- China has indicated it may readdress the status of Fentanyl and also the Qualcomm merger
A good meeting, but not great
Market expectations for the Xi-Trump meeting were for a truce in the trade war. This was even more positive. As anticipated in our forecast last week, the US agreed to postpone a raise in the tariff rate from 10% to 25%, which was meant to come into effect on January 1, 2019. Had that raise occurred it would have had very meaningful economic and market impacts. There is now strong evidence that both sides of the relationship are willing to negotiate. China Hawks Peter Navarro, Assistant to the President, Director of Trade and Industrial Policy, and Robert Lighthizer, US Trade Representative, who many thought were opposed to any concession or deal - not only took part in the meeting, but also in the subsequent dinner. The best indication of what this all means is shown by initial market sentiment. Hang Seng Index up 2.55% while NIKKEI Index up 1.0% on the first trading day after the meeting.2 Investors have decided the meeting was good - but not great.
A blunt instrument named Tariffs
It is worth unpacking the significance of tariffs. In short, they effectively become a tax that is either passed on to consumers or absorbed by the affected companies. The economic benefits of tariffs would be felt by almost no-one - especially in the US right now, considering the tight labor market and jobs growth. Furthermore, they don’t work in sophisticated supply chains. To use an iPhone as an example, less than half of the finished product is made domestically in China. Rather, they are bought from a variety of countries and companies, who might also be impacted. Thus - the implications of tariffs are wide-ranging but hard to predict accurately. One area that is always affected by tariffs is currencies. We could expect to see a short-term bounce for the RMB as the threat of future tariffs is removed.
Short-term implications to watch
This de-escalation could be beneficial right across Chinese markets, while other impacts are less clear. A Chinese agreement to buy more US agricultural produce is good for US farmers, and particularly soybean producers. There are also positives for the aircraft sector. The news is less good for Germany and Japan, whose industrial and manufactured goods may be shut out by China as the relationship with the US warms up. Also expect a negative bounce for agriculture across Brazil, Argentina and parts of Latin America. This is all about relative winners and losers.
Two major structural issues remain
Despite progress from last weekend, a number of figures in the Trump administration remain uncomfortable about ongoing structural issues with China. First and foremost they wish to confront the US trade deficit. Beijing’s wide-ranging Made in China 2025 initiative is unquestionably inward-looking and is creating a lot of consternation in the US. The other major contentious area is competition around tech, namely the protection of intellectual property, cyber theft, and “forced technology transfer” (often an unwritten rule for companies trying to access China’s burgeoning marketplace). These are long-standing issues that need long-term structural changes, and are harder to negotiate.
Will Trump get what Trump wants?
The priorities of President Trump are never clear, but some patterns are emerging. For all the words about unequal trading relationships, Trump doesn’t appear to want to be known as the president who caused an economic downturn. The US midterm elections indicated that formerly Republican-held farming areas may have turned Democratic in opposition to this year’s tariffs. Trump is also eager to show that he has been able to make progress on long-standing issues with China. As a result of last weekend’s meeting China has agreed to designate the drug Fentanyl as a Controlled Substance, meaning that people selling Fentanyl to the United States might be subject to China’s maximum penalty under the law. This change was pushed by President Obama years ago, without success, and the Chinese could still change their mind. Unexpectedly, China said it is now willing to support a merger between California-based semiconductor firm Qualcomm (QCOM) and Dutch counterpart NXP. How these negotiations play out might show just how cooperative the Chinese are willing to be.
What to watch in the next 90 days
This US administration is making it harder and harder to decipher the progress of negotiations. As we’ve all seen from the past year, President Trump can have positive one-on-one meetings, only to take to Twitter the following day with pointed rebukes. The best way to ascertain what is happening on both sides is to look to the structures set up in the next 90 days. Will they have high-level visits? How regularly will they occur and who will participate? It appears that if the discussions stick to trade - rather than the structural issues - then the relationship might continue to improve.
Looking at market opportunities to consider in the near-term, there are positive signs coming for cyclical sectors in Asia, such as gaming, financials and auto sectors - all of which were sold off throughout the year. Chinese equities also look positive based on valuations today - and where we see earnings growth going.
To discuss these ideas further, or to learn more about your portfolio positioning at this time, please contact your J.P. Morgan representative.
1Bloomberg. Data as of December 2, 2018.
2Bloomberg. Data as of December 3, 2018.