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Implications of a Deteriorating US-China Relationship

1 June 2020Asia PacEmerging MarketsEquities

Economic recovery has just begun, and is shaky with fears of relapse. Nevertheless, Citi analysts see promising signs for the US economy based on economic activity data that shows signs of progress in China, where the COVID-19 shutdowns came two months earlier. Citi analysts expect a similar, uneven pattern of manufacturing and consumer behaviors in Europe and the US, as both re-open. Slower recoveries are expected from leisure sectors and in industries where people need to congregate.

But US-China Tensions back in the forefront

  • Just as the world is straining to see the first light of dawn from this crisis, the conflict between the US and China was reignited.
  • President Trump threatened to revoke the Phase One trade deal, and said the US could cut off the whole relationship. The US instructed public pension funds to halt investing in Chinese equities and Congress is set to pass legislation that are expected to lead Chinese American depositary receipts (ADRs) to delist.
  • More importantly, President Trump announced to start the process of revoking Hong Kong’s special trading status among new measures to sanction China and Hong Kong after the National Security Law was passed. The sanctions, if materialized, may have limited direct economic impact given only 7% of Hong Kong’s exports go to the US. But it may hurt long term confidence for many businesses regarding Hong Kong as a regional hub. The Trump administration avoided outright sanctions against financial institutions, which could have been more impactful for markets.

    Implications of a Deteriorating US-China Relationship
    Past performance is no guarantee of future results. Real results may vary.

What does this mean for portfolios?

  • In the near term, there is likely to be more negative impact from trade conflict, as the excitement of initial recovery fades, and as economic tensions escalate to sovereign.
  • Citi analysts believe it is prudent for investors to consider hedging or reducing risk exposure as China/HK equities may underperform during the escalation of hostilities.
  • But ultimately, opportunities are also being created. The Hang Seng Index is again below book value, with the price-to-book (P/B) ratio sinking to 0.95x. At the depth of the COVID-19 crisis, this fell to a record low of 0.92x and markets rebounded.
  • In the long term, Citi analysts believe trade tensions are likely to have diminishing impact, as bipolar technology and supply chains take shape. As a result, Citi analysts remain committed to their positive views on consumption and tech driven growth in China.

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