China's growth story over the past 20 years has been epic—in just a couple of decades, it's gone from being a relatively minor player in the global economy to an economic powerhouse with a GDP of US$12.24 trillion in 2017. China is the second largest economy, only to the U.S., and will eventually take over the top spot. This growth and the sheer size of China's consumer makes it increasingly important to multi-national companies, and the global economy alike.
A zero-sum game?
While globalization has fostered growth in China and other emerging markets, it's also given rise to a growing perception of diminished economic prospects in developed economies. U.S. President Donald Trump campaigned hard on addressing that perceived inequity with a promise to make trade fairer for American companies and workers.
He's followed up on that promise in recent months with tough talk targeting long-standing trading partners, including China. As this happens, investors are concerned about what impact an all-out trade war between China and the U.S., notably the largest trading relationship in the world, could have on the global economy and markets.
With the U.S. looking more and more likely to proceed with greater tariffs on all imports from China, investors are now wondering what this means for them and what they should be doing next. Here are our key takeaways:
China is the main focus for the U.S.
We have little doubt that China is front and centre when it comes to U.S. policy on global trade, and “fairness" is very much the focus of its trade strategy. Consider this statement from the U.S. Trade Representative Annual Report: “President Trump has launched a new era in American trade policy. His agenda is driven by a pragmatic determination to the use the leverage available to the world's largest economy to open foreign markets, obtain more efficient global markets and fairer treatment for American works".(source: USTR 2018 Trade Policy Agenda and 2017 Annual Report).
More tariffs on China are very likely... and China is preparing itself
Unless China makes some important concessions, we think the U.S. is on track to implement tariffs on the full amount of Chinese imports (US$505 billion). It's not looking very likely that China will take those steps, in fact, Chinese policy makers have taken significant steps to offset proposed tariffs prior to U.S. implementation.
China's targeted measures to offset the impact of tariffs include devaluing its currency and encouraging banks to lend by reducing reserve requirements substantially. China has also cut taxes for small- and medium-sized businesses and for consumers—they've even cut taxes on car sales.
These steps are positive and should provide a cushion against the impact of rising U.S. tariffs on Chinese products and services. These measures should provide some relief resulting in a tailwind for the global economy in 2019.
Global growth may be seeing a transition
While globalization has produced winners and losers, it's generally perceived as a major positive contributor to the global economy. We are seeing signs suggesting globalization has peaked. We remain optimistic on the global economy and markets as a whole, but recognize that both economic and earnings growth are slowing entering 2019.
This means that global growth achieved via trade will recede and that countries like China which have historically relied on trade to boost growth will need serious economic reform to adjust. We've seen the markets adjust accordingly—trade sensitive stocks have under performed this year relative to stocks that are less exposed.
Made in China 2025, a clear sign China wants to drive growth domestically
In the past, China has benefited tremendously from globalization trends. Going forward, China will need to look inward for growth from its own domestic market and consumer base.
Made in China 2025, the country's strategic plan to move up the manufacturing value chain, is a reflection of Chinese aspirations to drive growth domestically. China hopes to become a leader in a number of high-tech industries and advanced manufacturing.
Positioning your portfolio
At the beginning of 2018, our view was positive for the global economy, but that the synchronized growth of 2017 would give way to expansion lead by North America, the U.S. in particular.
As a result, we continue to favour equities over fixed income as market conditions remain supportive overall and the probability of recession in the near future is low. From a regional perspective, we've been reducing our allocation to international and emerging market equities in favour of U.S. equities throughout the year. This has provided a buffer against recent international and emerging market equity weakness, partly driven by China-U.S. trade uncertainty, that we expect to continue.
If you have more questions about China's place in the global economy or in your portfolio, please contact your MD Advisor. He or she would be happy to provide more information.