The U.S. and China broke a five-month impasse on Friday in their long-running trade dispute, as negotiators reached a minideal “in principle” that suspended the U.S. tariff increase set for Oct. 15.
But optimism around the high-level trade talks might have been misplaced: Not only did the “deal” not address the thorniest issues at the heart of the dispute, but the conflict between the world’s superpowers widened in ways that could pose fresh challenges to U.S. companies and their shareholders.
President Donald Trump said the 13th round of trade talks reached a “very substantial phase-one deal,” adding that negotiations could include one or two more phases. Trump said it could take four to five weeks to get the deal on paper and signed, with details around enforcement and other issues still being worked out.
China agreed to buy $40 billion to $50 billion of U.S. agricultural products and scrap foreign ownership limits in its financial-services sector. In return, the U.S. suspended a planned increase in tariffs to 30%, from 25%, on $250 billion of Chinese goods. The administration hasn’t yet decided on the tariffs scheduled for December. Trump also said that the deal included some intellectual property protections and agreements on currency, but he did not offer any details. Earlier, business officials expected negotiations to focus on IP protections around copyright and trademark issues.
The Dow Jones industrials finished on Friday up nearly 320 points, or 1.2%, at 26,816, although stocks fell sharply from session highs starting around 3:30 p.m., when investors realized the two countries hadn’t made more progress. The latest agreement could still fall apart, and it lacks a resolution of major issues that would create a more level playing field for U.S. companies. These include a reduction or elimination of Chinese government subsidies to local companies; cyber theft issues, IP protections for data flows and computer source codes, and addressing technology and license transfers that U.S. companies often are forced to make in China.
Warren Maruyama, a partner at the law firm Hogan Lovells and a former general counsel at the Office of the U.S. Trade Representative, describes the deal as “very preliminary.” “Markets have been extraordinarily gullible,” he says.
Rajiv Jain, chief investment officer at GQG Partners, which oversees $26.5 billion, says market gains on a minideal would likely be an opportunity to sell. Jain doesn’t see a comprehensive deal on the horizon and notes that both sides’ interests are still far apart.
While a trade truce of any sort should be welcome, several new fronts have opened in the U.S.-China conflict. The Commerce Department added eight Chinese technology companies to its blacklist, including the facial-recognition firm SenseTime Group and the video-surveillance company Hikvision, and the State Department put visa restrictions on Chinese officials, citing in both cases China’s repression of Muslim minorities. The administration has also reportedly been considering restrictions on U.S. capital flows into China, which could hurt U.S.-listed Chinese stocks.
Nongovernment entities are rattling Beijing, as well. A tweet by a Houston Rockets official in support of pro-democracy protesters in Hong Kong ignited a firestorm in China this past week, briefly jeopardizing the National Basketball Association’s access to millions of basketball fans. Apple (ticker: AAPL) and the Google unit of Alphabet (GOOGL) had to pull protest-related apps from their digital stores, and a South Park episode critical of the Communist Party reportedly was removed from Chinese social media. These episodes point to a growing conflict for global companies—and their shareholders—between Western ideals of free speech and Chinese nationalism.
“We are already in a trade war and a tech war, and are talking about a capital war,” says Reva Goujon, vice president of global analysis for Stratfor, a consulting firm. “As those geopolitical fissures increase, companies are going to get caught in the middle.”
The global economy has already suffered. In a speech ahead of the International Monetary Fund’s annual meetings this past week in Washington, D.C., Kristalina Georgieva, the fund’s new managing director, said nearly 90% of the world is on track for slower growth. The IMF estimates that the trade conflict could inflict a cumulative loss of $700 billion in global economic output by 2020—roughly the size of Switzerland’s economy.
With less appetite for more tariffs, Goujon says, the U.S. search for leverage has been pushing it into more extremes, evidenced by the expanded blacklists and visa restrictions, which drew strong rebukes from the Chinese government.
“Beijing can’t be seen as bowing to pressure on issues where Chinese perceived sovereignty is under threat,” Freya Beamish, Asia economist at Pantheon Macroeconomics, told clients in a note, adding that tensions were likely to keep boiling.
Global companies will feel that heat. U.S. companies generate $544 billion in annual revenue in China—more than triple what the U.S. exports to China, according Arthur Kroeber of Gavekal Research. What’s more, with a population of 1.4 billion, China is a major source of growth. As the relationship between China and the U.S. grows more complicated, corporate costs could rise and growth targets might need trimming. Investors might also need to reassess the multiples they are paying for companies counting on expansion in China.
Lewis Kaufman, manager of the Artisan Developing World fund (ARTYX), is increasingly favoring European multinationals like LVMH Moët Hennessy Louis Vuitton (MC. France) for indirect Chinese exposure over the likes of U.S. companies such as Tiffany (TIF), Nike (NKE), and Starbucks (SBUX), whose shares he held in the past.
Any move by the administration to restrict government pensions from investing in China, or to delist Chinese companies trading in the U.S., would be an especially critical line to cross.
“It would signal that it is bad form to own these companies,” says Christopher Smart, chief global strategist at Barings, who formerly worked in the Treasury Department. “That creates a whole new investor risk calibration over and above tariffs on soybeans and technology.”
U.S.-listed Chinese stocks, or American depositary receipts, which are owned mostly by U.S. investors and based in tax-free jurisdictions like the Cayman Islands could be most vulnerable to declines. GQG’s Jain prefers China-listed A-shares, in part because of these risks. He also prefers well-run U.S. businesses trading at 21 or 22 times earnings, versus similarly valued Chinese ADRs such as TAL Education Group (TAL), New Oriental Education & Technology Group (EDU), or NetEase (NTES).
The risk of restricting U.S. government pensions from owning Chinese stocks is still theoretical, but some once-theoretical concerns, such as a technology cold war or visa restrictions and blacklists, have been realized. Investors who put more stock in the latest comments about preliminary partial deals than growing risks to the U.S.-China relationship should take note.
Source: Barrons October 14, 2019 | By Reshma Kapadia