As investors brace for the next turning point in the ongoing US–China trade war, will the clash between the two elephantine economies lead to a harrowing global recession?
BY RHB WEALTH RESEARCH
By the end of the first quarter, all signs were pointing towards a strong global economy in 2019. This is driven by several factors, including the thawing of the US–China trade war and the détente in relations between the two economic powerhouses, coupled with the supportive stimulus measures implemented by the Chinese government, as well as the dovish policy shift by both the US Federal Reserve (the Fed) and the European Central Bank (ECB).
And indeed, the global economy performed admirably well for the first quarter, as the MSCI AC World Index registered a strong first-quarter performance of 11.6%, and regional indices such as the MSCI AC Asia Index also registered first-quarter gains of 8.72% as at March 31.
However, this positive momentum dissipated in early May after US President Donald Trump unexpectedly hiked tariffs on US$200 billion worth of Chinese goods from 10% to 25%, and fired off a series of tweets threatening to impose 25% tariffs on roughly US$300 billion worth of Chinese imports. Tensions rapidly intensified after China announced retaliatory tariffs on US$60 billion of US products, effective June 1.
However, despite the increasingly hardline rhetoric, both sides remain open for a deal and all eyes are on President Xi Jinping and Trump as they prepare to meet at the G20 Summit in June, and it is all but certain that the outcome of their discussion would have major implications on how the global economy performs for the remainder of the year.
ARE WE IN FOR A RECESSION?
The million-dollar question on the minds of investors is: should we be expecting a recession to come in 2019? It could be argued that after a decade-long bull market cycle, it is due time for the market to correct itself. For 2019, numerous indicators, such as the near-inversion of the treasury yield curve, weaker housing activity, soft consumer spending, as well as deteriorating European economies and a lower-than-expected growth forecast for China suggest that investors should brace themselves for a bumpy ride ahead. Should the trade talks between the US and China break down, a global recession is a likely outcome.
Despite the blips caused by the escalating trade war, RHB remains cautiously optimistic over the outlook of the global economy in 2019 — provided that the situation does not deteriorate further. Our position is based on the strong fundamentals of both countries, as well as our optimism that both leaders are aware of everything that is at stake and would not risk destabilising the entire global economy.
In the latest minutes of the Federal Open Market Committee (FOMC) April/May meeting held on April 31 to May 1, the Fed decided to maintain the target range for the federal fund rate at 2.25% to 2.5% on the back of strong labour markets, economic activities rising at a solid rate and a low unemployment rate. FOMC members also agreed that many uncertainties affecting the US and global economic outlooks, such as Brexit and the US–China trade war, have receded and that global economic growth will continue its positive momentum, albeit at a slower rate compared with 1Q2019.
While the meeting was held at a time when optimism for a successful deal between the US and China was high, and before Trump more than doubled tariffs on Chinese imports, we believe that many of the fundamentals still remain intact and can sustain through this period of time. Furthermore, based on Trump’s aggressive stance and negotiation approach, we can conclude that the US remains in a relative position of strength compared to China. This is most evident through the US first initiating and escalating the trade war into a war on technology through the blacklisting of Chinese tech giant Huawei.
While China hardly desires a full-blown trade war, it is still standing firm and refusing to accept the terms demanded by Trump and the US. China is no pushover and is well prepared for slower economic growth through a series of fiscal stimulus measures announced at the start of the year. Premier Li Keqiang announced that the government will reduce taxes and fees totalling RMB2 trillion. The government has also cut value-added tax rates to 16% for manufacturing and 10% for agriculture, trans-port, construction, leasing services, wholesale and retail sales and real estate. The Chinese financial system also pumped a record RMB8.2 trillion in credit into the economy in the first quarter alone, and has issued RMB1.2 trillion worth of local government bonds for 1Q2019, most of which will be spent on infrastructure projects. These measures yielded robust results for the nation for the first quarter of the year, as GDP expanded 6.4% and all major indicators trended upwards. However, this growth deteriorated sharply in April after the government eased stimulus, with both industrial production and retail sales growth posting significant declines. While the government has remained tight-lipped about its policy plans on combatting US tariffs, there seems to be suggestions that further stimulus is possible if warranted.
Chief Investment Officer
Tan Jee Toon
Chief Investment Officer
Tan Jee Toon
A key point to consider is that a full-blown trade war bodes poorly for the leaders of both countries. Tariffs implemented by the Trump administration inevitably result in an increase in consumer prices and can have negative consequences on the economy. With the 2020 Presidential elections looming, Trump is betting that his voter base would focus more on the historically low unemployment figures and strong economic growth and, in turn, overlook the increase in consumer good prices. However, this is a dangerous gamble as a protracted trade war could particularly undermine his crucial support base in the swing states that voted for him in 2016.
A key point to consider is that a full-blown trade war bodes poorly for the leaders of both countries. Tariffs implemented by the Trump administration inevitably result in an increase in consumer prices and can have negative consequences on the economy. With the 2020 Presidential elections looming, Trump is betting that his voter base would focus more on the historically low unemployment figures and strong economic growth and, in turn, overlook the increase in consumer good prices. However, this is a dangerous gamble as a protracted trade war could particularly undermine his crucial support base in the swing states that voted for him in 2016.
Secondly, for Trump, failure to achieve a deal with China marks yet another setback in foreign diplomacy. It remains to be seen whether Trump and his administration would be able to swallow another diplomatic setback following the failure of his summit with North Korean leader Kim Jong-un earlier in the year. For Xi, despite being the country’s most powerful leader in decades, he has built his image on being a visionary and capable statesman. With the current conflict with the US already snowballing into one of the biggest setbacks in China’s foreign relations, he cannot afford to mismanage a bilateral relationship that has benefited China more than any other.
However, we must stress that this outlook is based on the sentiments and statements released at this given point in time. Relations have already deteriorated faster than expected and should the situation snowball into a tit-for-tat retaliatory affair with both countries imposing stringent tariffs on an assortment of imports, it is likely that the global economy could tip into a recession. Trump’s recent strike on Huawei could simply be a prelude to a full-blown technology cold war. Furthermore, there are already whispers that China is ready to limit, or worse, ban the supply of rare earth minerals. Rare earth minerals are vital components used extensively in the manufacturing of a large number of products ranging from smartphones and batteries to turbines, lasers, camera lenses and stealth technology. China produced over 90% of the world’s supply of these critical elements over the past decade and should Xi decide to embark on this option, it would result in unimaginable consequences for the US, which only produces less than 10% of the world’s supply and imports half of what it consumes. However, RHB believes that this response from China is unlikely, given that such a move is mutually destructive.
INVESTMENT STRATEGIES
FOR THE REMAINING YEAR
While the escalation of the trade war was something that caught the entire market by surprise, RHB believes that there is no need to panic as long as investors have properly diversified their portfolios. Despite the escalation in tensions between the two global economic superpowers, our approach remains the same. We are optimistic that both countries are able to reach a mutually agreeable deal and that the major themes we identified for 2019 remain intact. Since the start of the year, sector-wise, we have favoured the healthcare and technology sectors.
Despite the trade war, healthcare will remain relatively unaffected as the sector will benefit from a continually ageing global population. In addition, technological developments have been consistently delivering breakthroughs. differentiated internet companies will continue to replace existing services and seize market share from traditional bricks and mortar players. We believe that the internet sector will remain relatively unaffected by the trade war and that it is inevitable that advancements would continue to yield return for investors for the remainder of 2019 and beyond.
From a geographical standpoint, RHB still believes in the growth story of Asia and Asean. With the conclusion of general elections in Indonesia and the Philippines, where the popular incumbent candidates won comfortably, we continue to be positive on these growing economies.
We also continue to favour Chi-na’s growth story and believe that, unlike first half of 2018, the country is more prepared to deal with the US-China trade war this year. For example, the recent Reserve Requirement Ratio cuts in May is a strong statement of policy support and flexibility from the Chinese government. In addition, China will continue to ease and stimulate on numerous domestic fronts. Notably, we continue to build our positions in domestic sectors that will benefit from policy stimulation of domestic consumption. We also like infrastructure-oriented and property companies as potential policy easing beneficiaries, providing a hedge against escalation of trade tensions. The inevitable increasing of China equity weights due to MSCI inclusion and the opening up of the financial sector in China will continue to provide investors with ample investment opportunities over the medium term. However, volatility is expected to be high as we move into a new phase of the trade war.
Ultimately, in these volatile times, stock selection is the key to success. We will continue to dutifully monitor political and market developments — especially the G20 meeting at end-June — and will look to accumulate quality names at attractive price levels. However, we must stress that global political situations can shift in the blink of an eye. Investors must understand that the investment journey is one that is never smooth sailing and it is in their best interests to align themselves with a reliable investment manager with the expertise to navigate through these turbulent times.
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