switzerlanden
The new Long March of China

The new Long March of China

07-06-2019 | Monthly outlook
China’s attempts to combat a trade war with the US present an uphill battle for emerging market assets, says strategist Peter van der Welle.
  • Peter van der Welle
    Peter
    van der Welle
    Strategist

Speed read

  • China prepares to dig in for the long haul against the US
  • Retaliatory weapons including devaluing the yuan may backfire
  • Multi-asset portfolio is now underweight emerging equities

President Xi Jinping has likened China’s challenge of overcoming hostility abroad to a “new Long March”, a reference to the Red Army’s epic 9,000 km, year-long retreat in 1934-35 from the then ruling Nationalists. It marked the rise of Mao Zedong and the birth of the communist nation.

His comments follow President Trump’s latest trade war escalation in which he raised tariffs on USD 200 billion of Chinese imports and threatened to slap a 25% tariff on another USD 300 billion, dashing hopes of a trade deal in May. The trade war is particularly troublesome for emerging markets equities, leading Robeco Investment Solutions to go underweight on the asset class in its multi-asset portfolio.

The IMF estimates that a full-blown trade war could shave 0.5% off US economic growth and 1.5% off China’s. With Chinese equities selling off by 13% in May, investors clearly have been discounting the odds of prolonged trade tensions, Van der Welle says.

“According to Xi, China is now on a ‘new Long March’ to overcome major challenges abroad,” he says. “The Long March analogy seems well chosen. It will still take decades for it to overtake the US in terms of GDP per capita, but China’s sheer size in terms of population and the aspirational goals set by the Communist Party have already put the country in the challenger position.”

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

A warning to Trump

“The pivot may also be read as a warning to Trump that trade wars are not ‘easy to win’, especially before the November 2020 US presidential elections, as China will be going for the long haul. Time may be on Xi’s side, but using this analogy also enables him to better explain an eventual near-term compromise on trade to Chinese citizens as a ‘tactical’ retreat in a broader setting of long-term geopolitical strife.”

“The largest incentive for the Chinese government to seek a compromise of any sort on trade is rising unemployment and the accompanying discontent among Chinese workers. With the Chinese PMI manufacturing employment index dropping in May to the lowest reading since March 2009 (47.0), past monetary and fiscal stimulus by Chinese authorities has clearly not been enough to mitigate the hit from US tariffs on an economy that was already cooling.”

“The first line of defense is more monetary and fiscal stimulus by Chinese policymakers, but a persistent drop in employment numbers could instill enough fear of social unrest for Chinese policymakers to eventually reach for a compromise on trade.”

Retaliatory toolkit

Van der Welle says China has three retaliatory weapons at its disposal: restricting the rare-metal exports that the US relies on, selling its USD 1.2 trillion war chest of US Treasuries, and currency depreciation. The first two options are unlikely, he says, as they would be self-defeating, but “the most potent threat from the Chinese side remains a devaluation of the yuan.”

“A much cheaper yuan could mitigate the impact of additional US tariffs on the remaining USD 325 billion of Chinese exports to the US. However, the lesson learned from yuan devaluation in September 2015 is that it can backfire due to spiking volatility and tightening financial conditions in Chinese markets.”

“Ultimately, the short-term gain of a strong devaluation of the yuan would do long-term damage, as it would undermine China’s long-term intentions to gradually further open its capital markets to foreign investors. Is it a coincidence that at a time when the risk of a managed Chinese currency depreciation as a retaliation weapon grows larger, the US Treasury releases a report in which it toughens up its currency manipulation criteria? Probably not.”

“Cognizant of these self-defeating aspects of retaliation, Xi Jinping is now aiming for a “new Long March”. At face value this seems reassuring, as does his willingness to seek compromise around the upcoming G20 summit on 28 June in Osaka and his efforts to restore the recent dent in the great postwar liberalization of trade. It is not a given though; will Chinese defense systems make use of US software in the future (and vice versa)? The Chinese leader could very well be envisaging a new long march at home, not abroad. Protectionism will linger for longer.”

Emerging markets to suffer

None of this bodes well for emerging market assets, Van der Welle says. “Unfortunately, the recent escalation in the China-US trade tensions and the opening of new fronts by the Trump Administration create additional downside risk, especially for more export-oriented countries that benefit from global trade,” he warns.

“In response to the negative news flow on trade, emerging market equity price momentum has worsened compared with developed market counterparts. This is understandable, as when protectionism rises, global trade volumes decline, and the earnings growth catch-up of emerging markets is hampered.”

“Enhancing corporate productivity growth by copying Western technological standards will become more difficult if trade barriers are pulled up. In a world of protectionism, emerging economies must enter the uphill battle of pushing the frontier of technological progress themselves.”

“Also, the recent decline in oil prices, reflective of lower global demand, is not helpful for emerging economies’ earnings recovery in the near term. As the valuation discount of emerging markets compared to developed markets is not particularly attractive compared to the average historical discount, we have become more cautious on emerging market exposure and lowered our emerging market equity positioning from neutral to a modest underweight.”

Subjects related to this article are:
Logo

Important legal information

The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.

The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.

Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.

This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.

I Disagree