White House turns up the heat on China

Thought of the day

by Chief Investment Office 02 Aug 2018

Chinese shares came under pressure on Thursday, with offshore and onshore equities falling as much as 2.7% and 3.6% intra-session before selling eased into the close. The fall followed a White House threat to increase the tariff on USD 200bn of Chinese imports from 10% to 25%. Meanwhile investors are also worried by slowing Chinese growth and the recent fall in the yuan, which is down more than 8% versus the US dollar since late April.

This deterioration in US-China trade relations is not a welcome development for risk sentiment, and could lead to heightened market volatility in the near-term. However, there are still a number of compelling reasons to retain risk exposure to China equities:

  • Valuations appear cheaper. Price to 12-month forward earnings for MSCI China are now at slightly above 11x, which is 15-20% below what the market was pricing at the beginning of 2018. And yet earnings growth looks very strong, tracking near 15% for full year 2018. 
  • Policy support incoming. China’s semiannual Politburo meeting confirmed a tilt toward easier fiscal and monetary policy, while reiterating plans to reach current growth targets. The more the US ramps up its external threats, the more supportive China policy is likely to become. 
  • An opening for talks. Buried behind the headline 25% figure is an extension in USTR comment period to 5 September, offering slightly more time for US-China negotiations. Recent reports suggest Mnuchin and Liu, both seen as more conciliatory on trade, have re-ngaged in high level talks. 

So while we cannot rule out further escalation in trade tensions or continued pressure on risk assets, we still see reason to maintain our preference for offshore China equities within our Asia portfolios. We have made several adjustments already, including reducing our position in Asia Ex-Japan equities to neutral last month.

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