Jan. 10, 2019
The Federal Reserve Open Markets Committee finally admitted it. China is a problem. Not in the way that President Trump and the hawks in his cabinet say China is a problem. But higher U.S. interests rates are a problem, not only for U.S. equities but for all of China.
According to their meeting minutes released on Wednesday, “concerns over escalating trade tensions, global growth prospects, and the sustainability of corporate earnings growth were among the factors that appeared to contribute to a significant drop in U.S. equity prices.” The government shutdown, or the threat of a shutdown, was not even mentioned as a potential headwind for stocks.
China and the Fed are all that matters to Wall Street. And China is starting to matter more to the Fed.
This is why the market has been up over the last four trading sessions: a more dovish Jerome Powell on Friday totally trumped the negative China-related headline from Apple CEO Tim Cook on Thursday. The market has been up since. And after a three-day trade meeting between mid-level U.S. diplomats and the Chinese government, even the Shanghai and Shenzhen stock markets are on the mend. (Though don’t get your hopes up on the A-shares.)
On the business side, the U.S. China Business Council, one of the biggest DC lobbying firms for American businesses in China, wants to remind the Trump Administration that today’s closure of the three-day trade talks is just the beginning. The 90-day trade truce agreed to in November, ends in March. A substantial deal is unlikely before then.
“We urge both governments to use the time remaining in the 90-day negotiating period to make tangible progress on the important issues at the core of the current dispute: equal treatment of foreign companies in China, as well as China’s intellectual property and technology transfer policies,” says Craig Allen, the Council’s new president. “That progress should include a regularized, results-oriented government-to-government dialogue that produces measurable, commercially meaningful outcomes addressing the concerns of American companies.”
For years, U.S. companies have stood down when it came to China. They figured it best not to complain or risk upsetting their China partners, who are apparently easily triggered. But those days are gone.
Although members of the American Chamber of Commerce in China will all say that tariffs are hurting their businesses and are a generally bad idea, none of them have any idea how to push China for market access. They will all say this to you in closed-door conversations in Washington and Beijing.
They also do not know how to stop their partners from stealing their patents and making the same thing at another factory for less, thus destroying their business. If not destroying their business, definitely taking away market share not only in China but throughout Asia, which happens to be the most coveted market in the world.
The trade war has not stopped U.S. companies from bending over backward to please Beijing.
China’s economy is slowing, as the Fed noted. But it is the No. 2 economy. That’s not changing. China matters more than ever.
They are being hurt more from the trade war because China is much more dependent on exports than the U.S. But many of the companies exporting out of China are doing it on behalf of their American partners. China is a major part of the American supply chain, a potential problem for companies like Apple.
Apple may be reporting weaker earnings due to lackluster sales in China, but there will be other companies who are seeing profit margins shrink because of higher tariffs in the next round of corporate earnings. The Fed said today that it is going to be mindful of that.
China: Patience Is A Virtue
Meanwhile, China plays the long game here. Xi Jinping knows that, unlike him, Trump is not going to be president forever. And while the Democrats are not much help to him, they have been more friend than foe in the past. Barack Obama mostly opted to use the World Trade Organization to tariff certain Chinese imports, like tires for example. If a Democrat was elected president next year, China can live with an Obama-like approach to trade.
China can wait Trump out, which means the trade war is far from over. One would have to believe that Xi gives in and inks a deal that legislates intellectual property rights for foreigners and grants market access for sexy industries like finance and energy. It is unlikely he does both by March. What are the odds of those things happening by the end of this year? Next year is an election year. What is China going to do to make life easier for Trump in 2020? Probably nothing.
The current tariff regime is less than a year old. And Xi knows that despite the slowdown, it has not hurt his country’s long-term outlook. Short term, investors don’t really like China. Long term is another matter altogether.
Economists predict China will be the world’s largest economy in 10 years in terms of total GDP. China is already the number one driver of global economic growth. Trade, public debt, and economic reform matters are not insurmountable, UBS analysts wrote in a recently published report titled “Taking the Lead: How China is Driving the Global Economy.” Taking time on issues like trade, public debt, and open markets are especially true for a leader with no term limits and no opposition. Any opposition to Xi’s approach to fighting Trump on trade is largely silenced.
Trade tensions are still a headwind for China’s A-shares — down over 25% in the last 12 months — and for the Fed.
The Fed is likely on hold for at least the first half of the year, Neuberger Berman CIOs led by Joseph Amato wrote this week. “If the U.S. experiences a soft landing and moderate risk-asset market returns in 2019, it will be in no small part because the Fed resisted the impulse to overshoot with tightening.”
If the current expansion lasts until June 30th, 2019, it will become the longest ever economic upcycle.
“The U.S.-China conflict is troubling and seems to be broader than mere trade policy,” says Bob Doll, chief equity strategist for Nuveen. “Judging how these issues might influence economies and financial markets is complicated, but they are unlikely to be positive.”