Changing Global Trade Relations

Since May’s ratcheting up of trade disagreements, the US-China tariff / technology war has negatively affected equity indices globally while positively affecting developed country bond markets. As much of the conflict is about rival political systems and hegemony, the odds of this conflict greatly dissipating is unfortunately quite low.

However, both sides have interest in containing the ramifications, so they will likely continue to negotiate and trade while restraining harshly aggressive acts. The situations in Hong Kong and Taiwan will also be important factors, however, as to whether China can avoid harsh actions, as politics often triumph over economic logic and well-being.

It is also important to note that Korea and Japan are now using political considerations, along with heightened national security issues, as a factor in their trading relationship, so this trend could spread to their relationships with other countries. In many ways, we are entering into a new kind of world for global economic and political relations.

Traditional Globalisation – Past Its Peak, but There Will Be Winners

Indeed, it seems inevitable that there will be a global bifurcation of tech industry standards and reduced integration of China in the global supply chain for Western products, with China building its own supply chain for its own products. Both imply growth opportunities for companies building out these dual supply chains, like semiconductor production equipment providers, but dual production will clearly entail some degree of inefficiency and burdens for global production, as well. It is important to note, moreover, that in order to succeed in such, China will need every single component and software technology for an item, which will be difficult to achieve reliably. Logistical and production problems will likely arise for non-PRC companies, as well.

Thus, globalisation is not dead, but it is past its peak in the traditional sense as politicians, especially in developed countries with trade deficits, realise that it can be quite dangerous to social order and national security. Also, China has always believed in the national security implications for most technologies, especially the internet, where there has long been a bifurcated system.

For all the negatives of bifurcation, however, there is at least one other positive factor, in that the capacity reduced in China will be built elsewhere. Vietnam is likely the largest beneficiary, although it will have to be very careful about avoiding trans-shipments and protecting intellectual property rights and reducing state subsidies. The rest of ASEAN and South Asia will benefit too, with Singapore further boosted as a regional financial and entrepot centre.

Additionally, the US is benefiting from increased foreign investment due to its efforts to reduce its trade deficit. Both Japanese and European automakers are building new factories, including the first new factory in Detroit in many decades. Meanwhile, Taiwan’s Foxconn is building an LCD factory and Samsung is said to be studying a semiconductor foundry there too. A key question is whether any cell phones or computers are ever assembled in the US, as without such, its major electronics trade deficit will not shrink substantially.

Lastly, China has long been moving towards globalisation with its Belt and Road and other initiatives. This increases global economic growth, especially in emerging economies, and will likely be accompanied by China building a globalised manufacturing chain. Indeed, it should not be long before China imports most low-end manufactured goods from other countries, with many of its companies producing more aggressively abroad. Thus, investors should expect bifurcated globalisation in the years ahead, with some element of overlap between the two systems.

Cautious on Equities, but We Do Not Expect Recession in the Near Term

The trade conflict is now accompanied by a “lower for longer” interest rate trend. This is associated with currency wars to gain competitive advantage, the desire to keep government interest payments low and help economies deal with the economic slowdown caused by trade disruptions and the associated decline in corporate and consumer confidence.

Inflation is not threateningly low, especially considering the rise in housing prices, and a full recession is unlikely the next year. That said, the cycle is already highly extended and a global recession will eventually come. Businesses are well aware of this and do not wish to over-expand before such. The bond market is thus rightly concerned about a slowdown but there is a high degree of risk that bond yields could snap back.

Associated with the decline in interest rates, many commentators believe that the world is Japanifying, or in other words, heading towards a prolonged period of stagnant growth, deflation (or at least “no-flation”) and loose monetary policy. However, Japan is quite unique among countries, especially given the leading role that declining property prices had in quelling optimism and subduing inflation. That said, if property prices did start declining in the rest of the world, the Japan example would be more applicable.

Beyond interest rates, central banks will never completely be out of ammunition to counteract a recession, but they are clearly shooting many of their bullets early and there is always the chance that investor trust in responsible monetary policies will sink quite sharply, in which case, precious metals would rally further.

Our view is that tariffs on the rest of Chinese goods will gradually rise to 25%. We also expect that this and other factors, including geopolitical ones like Brexit, would lead economies to grow at under consensus, although not recessionary rates. As a result, our Global Investment Committee took the extremely rare stance of underweighting global equities at our late June meeting and we still recommend caution, but we are not highly underweight, as we do not expect recession in the near future and realise that equities remain valuable from a long-term perspective.