Will tensions between the U.S. and China keep rising?
It has become a near daily occurrence to awaken to headlines stating that “tensions between the U.S. and China are rising”. Indeed, tensions between the two countries have risen this year, a less positive example of a pre-pandemic trend that has gotten further amplified in the COVID-19 world. A spark was international concerns about China’s initial handling of COVID-19 and its transparency on the issue – and an accelerant has been the upcoming U.S. Presidential and Congressional election in November.
Tensions will likely continue to rise in the lead up to the election, as both Republicans and Democrats compete on who would be tougher on China. A Pew Research Center survey conducted between mid-June to mid-July 2020, shows that 73% of U.S. adults have an unfavorable view of China, up from 47% in 2018. Republicans have a more unfavorable view of China than Democrats (83% vs. 68%), but the trend has been upwards regardless of partisan affiliation, making China a key campaign issue for both parties.
After the election has come and gone, the volume of tensions is likely to be dialed down, but to a new higher baseline. Competition between the U.S. and China is likely to be a key fixture of the investing landscape during our lifetimes – and perhaps beyond. As China’s economy, markets, innovation and military rivals the U.S. more and more, both countries will compete in a variety of spheres, including trade, technology, capital flows, human rights, security, health care and the environment. However, given the economic and geopolitical importance of both countries, competition is likely to be sprinkled with a mix of collaboration depending on the issue.
As such, investors will need to invest through the heightened tensions by asking themselves the following questions:
1. In what type of sphere are the tensions taking place? Contrary to the past two years, this year’s tensions have not involved trade. In fact, the Phase I trade deal has been left in place so far. Instead, competition has been focused on technology, capital flows, human rights, security and health care.
2. Does the action impact corporate fundamentals? Contrary to the 2018 - 2019 trade war, this year’s tensions have not involved spheres that have broad macro importance for markets. Some actions involving technology, capital flows and health care do have implications for specific companies; however, its more limited scope has kept the headlines high but the broad market volatility low. Should tensions move into the trade realm again, short-term volatility may pick up. In addition, it is key to look at any announcement in detail in order to see if it is more symbolism than substance in practice.
3. Does this change the case for investing in China? China’s economy, equity market and bond market are now the second largest in the world. Over the next decade, China will not have as much of a tailwind for its growth as it did in the previous decades; however, it is on track to become a high income country, bringing up 500mn people into the middle class during this time period. The growth and development of their consumption patterns is one of the biggest growth opportunities of the next decade. In addition, Chinese technology companies are increasingly competitive on the global stage. Progressively, investors have more mature Chinese markets through which to access these themes – and more and more the need to go directly to the source to invest in them.
While it may seem this way at times, it is not about the U.S. or China. Both will need to co-exist in the global landscape – and in investors’ portfolios as core holdings.
Competition between U.S and China takes many forms
|Type & scope||U.S. action||China action||Risen this year?||Matters to investors?|
|Trade||Goods, services, tariff and non-tariff barriers, industrial policy, currency||Signed Phase I deal in January; removed China as a currency manipulator||Purchased 46% of prorated year-to-date target of U.S. goods; improved financial market openness; refrained from CNY devaluation||NO||YES|
|Technology||5G, AI, cloud computing, social media, digital payments, hardware, semiconductors||Pressured countries to remove Huawei from networks; restricted non-U.S. companies from producing Huawei chips; expanded list of Chinese companies on Entity List; proposed banning U.S. persons' transactions with TikTok & WeChat||YES||Specific companies|
|Capital flows||Exchange listings, portfolio investments, foreign direct investment, banking system||Potential de-listing of Chinese ADRs based on U.S. audit requirements; restricted U.S. federal pension fund investments in Chinese companies||Chinese companies started dual-listing on HK/mainland exchanges in anticipation of U.S. exchange listing changes||YES||Specific companies|
|Human rights||Hong Kong national security law, China's treatment of Uighurs in Xinjiang||Sanctioned 11 Chinese/HK individuals involved with HK law; suspended HK's preferential treatment over China; sanctioned 6 Chinese individuals and 1 entity related to treatment of Uighurs||Sanctioned 11 U.S. individuals in retaliation for HK-related sanctions; sanctioned 4 U.S. individuals in retaliation for Uighurs-related sanctions||YES||NO|
|Security||South China Sea, Taiwan, Belt and Road Initiative, ideology, cybersecurity||Declared China's claims on South China Sea illegal and continued naval exercises; closed Chinese consulate in Houston; restricted number of Chinese journalists in the U.S.; first senior U.S. official visit to Taiwan in 40 years||Continued incursions in South China Sea; closed U.S. consulate in Chengdu; expelled U.S. journalists from China; sanctioned Lockheed Martin for its involvement in U.S. arms sale to Taiwan||YES||NO|
|Health care||Production of medical equipment and PPE, biotech, R&D||Blamed China for COVID-19 spread; competing in race for COVID-19 vaccine/treatment; charged two Chinese hackers for allegedly stealing vaccine research; proposed bills to re-shore production of medical equipment , PPE, and pharma||Blamed U.S. for COVID-19 spread; competing in race for COVID-19 vaccine/treatment||YES||Specific companies|
|Environment||Climate change, renewable energy, energy efficiency||NO||Specific companies|