Global Economy: Risk of a trade war not over

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 10, 2017 - April 16, 2017.
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Investors should keep a close watch on trade tensions between the US and China in the months ahead as there is still a possibility it could escalate into a trade war and affect key sectors like automotive and steel.

To prepare for that eventuality, fund managers advise investors not to be overly exposed to companies that rely on global trade and to allocate their investments to domestic-related themes instead.

The most prominent risk that will trigger a trade war would be US President Donald Trump’s failure to pass his major domestic bills, says Amundi Hong Kong Ltd chief economist for Asia ex-Japan Mo Ji.

“This will be the tipping point. If Trump can’t pass his major bills, his administration may turn on China. He might issue a presidential executive order that may trigger a trade war, such as anti-dumping [duties] on specific sectors, including automotive or steel. They could be very tough on the terms, which could cause uncertainty for the international community,” she says.

Simon Baptist, chief global economist and managing director of the Economist Intelligence Unit (EIU), says companies in the automotive and steel sectors globally could see higher volatility moving forward as a result of the uncertainty caused by Trump.

“Trump is eventually going to increase trade barriers and certain countries could be targeted, such as China and Mexico. You will probably see trade barriers being imposed for US automotive and steel, which are the sectors supporting the midwestern states. He might do it to make a political point,” Baptist says.

After more than 100 days since Trump took office, the lack of real progress in implementing major domestic bills has seen him switching his focus to other plans on his election campaign agenda, such as reshaping US trade policy.

So far, Trump has seen one of two major bills hit a dead end. On March 25, the Republicans in the US House of Representatives withdrew a healthcare bill drafted to repeal and replace the Affordable Care Act, or Obamacare, due to a lack of support within the party.

The healthcare bill, together with the tax reform bill, is high on Trump’s priority list. The US dollar weakened against the euro, yen and gold after the withdrawal of the bill. The US stock market also took a dip.

On March 31, he signed two executive orders to review and fight foreign trade “abuses” that have contributed to a US$500 billion trade deficit. The orders require a study to be done by country and by product, and require officials to develop a better way to collect punitive anti-dumping and anti-subsidy duties on foreign goods.

OCBC Singapore vice-president and senior investment strategist Vasu Menon shares Ji’s view, saying a trade war could be triggered if domestic politics do not play out according to Trump’s expectations. Global growth would also be threatened.

Other risks, he says, include the FBI’s investigation into Russian interference in the US election. “A trade war is a trump card [the president] can use to distract US citizens from any difficult issues he runs into,” he says.

Further tensions could arise between the leaders of the US and China, at least when they face each other at the negotiating table, says Baptist.

He says Trump and Chinese President Xi Jinping are now in a period of consolidating political power within their respective countries.

“Trump, a businessman without any political experience who became president, is trying hard to strengthen his position within the Republican Party. Xi, meanwhile, will be facing the 19th National Congress of the Communist Party of China in the second half of this year,” he says.

The national congress is held every five years for the party’s top-ranking members to elect the next president of the nation.

Meanwhile, the renminbi, which has been on a weakening trend since 2015, could be another potential risk to triggering a trade war, says Menon.

He says if the renminbi falls to a level much lower than what the markets are expecting, it will leave Trump with no choice but to initiate a trade war with China by imposing trade tariffs.

“We are looking at the renminbi weakening to 7.08 against the US dollar in the next 12 months. But if it has a drastic fall to, say, 7.5 against the US dollar, it might be the tipping point for Trump,” Menon says. As at March 28, the renminbi was trading at 6.89 against the US dollar.

Apex Investment Services Bhd regional fund manager Gary Lim says the possibility of the renminbi weakening beyond market expectations could come from the cracks in China’s financial system that are causing outflows from the country.

“It could happen. People have been wondering if the turnaround of China’s economy is sustainable. There is high leverage and indebtedness within the Chinese corporates and economy. If the Chinese economy goes south and sees rising non-performing loans and more outflows [as a result], I don’t think that would be acceptable to the Trump administration.”

Should there be a trade war, Lim says equities, in particular Asian equities, would likely see a sell-off, given Asia’s position as a supplier of goods to the US consumer and even capital goods for corporates.

“And we will see greater pressure on those countries that are seen as more open economies and highly trade dependent such as China, Hong Kong, South Korea and Taiwan in North Asia. In Asean, it will be Singapore and Malaysia. Export-oriented sectors will also experience greater selling pressure.”


However, as serious as it can be, a full-blown trade war between the US and China is not the base case scenario, says Ji.

While investors should keep a close watch on the risk of a trade war, which could cause turmoil in the global economy, they should not treat it as a base case scenario when it comes to strategising their investments.

“We view the chances of a trade war occurring as low. It is highly possible that China will not manipulate the currency as that would hurt the country and global economy,” she says.

If the US were to initiate a trade war by accusing China of being a currency manipulator, Ji says, China would most likely turn to the World Trade Organization to protect its trade rights. “We think China will set a good example of how to respond, and the best way would be to turn to the WTO. As the organisation takes three to five years to review cases, Trump’s administration would not be patient enough to wait it out. In this case, they won’t win or gain anything from initiating a trade war.”

She says China’s economy has recently stabilised and the renminbi is more likely to appreciate against the US dollar rather than depreciate.

Pacific Mutual Fund Bhd CEO and executive director Teh Chi-cheun says the renminbi has been on a weakening path since January 2015, falling 9.8% against the greenback. It is the second worst-performing currency in Asia following the ringgit, which has dropped by 21%. However, the US dollar has also begun to weaken, starting in January this year, as shown by the US Dollar Index.

The index — which measures US dollar strength against a basket of currencies involving its key trading partners, such as the euro, yen, pound sterling, Canadian dollar, Swedish krona and Swiss franc — has been on a downward trend starting this year, says Teh. “It started to weaken again in the middle of March when the healthcare bill was really at risk. In my view, the US dollar will still be where it was at the beginning of this year moving forward.”

There is concern that the US Federal Reserve might raise interest rates more aggressively than the markets expect if the country’s domestic economy picks up. This will prompt the renminbi to depreciate, which will create tension between the US and China.

However, Teh says the Fed has reiterated quite clearly that it will be raising rates three times this year, which should not cause the renminbi to depreciate to a level unacceptable to Trump.


Pacific’s Teh advises investors to be mindful of the risk of a trade war, but not to overreact. Excluding black swan events that could derail the market, global trade is recovering and picking up, he says.

EIU’s Baptist says the global economy is forecast to grow 2.6% at the end of the year, compared with 2.2% last year. The growth will mainly be driven by the improvement being seen in the US.

In fact, Malaysia, which is highly depending on global trade, is where investors should look in the short term, Teh says. “I would recommend starting to focus on ringgit assets. If you look across the region, Asian currencies have rebounded and we are standing out strongly as a laggard.”

Looking at sectors, Teh favours commodities and banks globally. The former is because commodity prices have bottomed out and stabilised while the latter is due to improved loan quality and the sector is undervalued.

“I like commodities as companies can start to do sound investment and planning, which they have been holding back on. I have been talking it up since last year.

“Meanwhile, local banks [in general] are trading at one time price-to-book; it is very attractive. Banks will improve from economic growth locally and globally,” he says, adding that local banks are still relevant in the local economy.

Having said that, Teh says investors should always follow the principle of global diversification as the market could always head south due to unexpected incidents. This includes possible terrorist attacks in Europe that could swing votes to far-right parties in a series of upcoming general elections.

“In the medium to long term, I always emphasise global diversification,” he says.

Apex’s Lim says Hong Kong and China shares are undervalued compared with the US. “The US has been on a bull run for seven to eight years since the Lehman collapse. It is above the crisis peak and is more vulnerable to a sell-off. And if you look at Asia, it is still below the peak and the economy is just starting to recover.”

Lim says Asia will be the beneficiary of the volatility seen in the US and European Union. “If volatility intensifies, it will accelerate the prominence of Asia in the investment sphere. You are likely to see quite a bit of asset allocation potentially flowing into the region. Compared with Europe, the Asian equity market is smaller and it doesn’t take a lot of money to shift the markets. In fact, you can actually see by now that a lot of global money has been put into Asia — and Malaysia is also finding favour.”

On the European side, Teh favours the pound sterling as it is deemed undervalued. The pound is expected to bottom out after Prime Minister Theresa May triggered Article 50 for the UK’s exit from the EU. There will be another round of volatility when the former starts to negotiate trade terms. “It depends on how well or badly the negotiations go. But the thing is, [the pound sterling] will strengthen first and when it drops again, you won’t see the same low.”

Other currencies he likes include the Canadian dollar, which is expected to benefit from the country’s proximity and trades with the US.

Lim says investors should be mindful of the risk and position their investments accordingly. “It is hard to put a percentage on how likely [these scenarios] are. However, investors should always be prepared for potential major risks, even those that few foresee. We are positioning ourselves to try to minimise the risk as well.”

His advice to investors is to not take a large position in export-related sectors that would be directly affected if a full-blown trade war were initiated. Instead, investors should invest part of their portfolio in themes and sectors that will benefit from domestic factors, instead of global trends, and companies that are undervalued.

Consider South Korean banks

Apex Investment Services Bhd regional fund manager Gary Lim likes South Korean banks due to cultural changes in the country, which is one of the investment themes not tied to global trade issues.

In December last year, Park Geun-hye, the ex-president of South Korea, was impeached over a scandal in which she allegedly allowed her close friend Choi Soon-sil to extort money from big firms and channel it into a non-profit organisation she controlled.

In March this year, the Constitutional Court of Korea upheld parliament’s impeachment decision, causing Park to lose her immunity against prosecution. She was then summoned by prosecutors to be questioned and could face a jail term.

Lee Jae-yong, the billionaire heir to Samsung, was also arrested as he was accused of bribing Choi, who allegedly colluded with Park, with US$40 million to gain political favour and consolidate his influence within Samsung.

Lim says this incident shows the changing mindset of the South Koreans, who are more aligned to Western free-market values compared with Asia’s controlled economy values.

These changes will benefit South Korean banks, which are now trading very cheaply, some as low as 0.4 times price-to-book value (P/BV).

“Under the country’s controlled economy, the government supported big chaebols (large business conglomerates, typically family-owned) like Samsung, Hyundai and LG to grow into the big global companies they are today. To do so, South Korean banks provided loans under pressure and took orders from the government, even if some of the projects didn’t make sense. Banks were also required to support these companies when they got into trouble. This was the strange relationship between the South Korean government, banks and chaebols. And this is part of the reason why the banks are trading at 0.4 times P/BV because no one believed their books.

“However, things changed last year. The most significant event was the impeachment of the president and the Samsung chairman being placed under investigation, and possibly facing a jail term. On the company side, you also see big companies such as Hanjin Shipping declaring bankruptcy, which is rare in South Korea. Usually the banks would be asked to bail out and support these companies. All these things point to the fact that the previous way of doing things is no longer deemed acceptable,” he says.

Lim says rating agencies are likely to rerate South Korean banks on the back of more reliable books and improved transparency.

“If you continue to throw good money after bad companies, your books are highly questionable. But if zombie companies are allowed to go bankrupt, it is due to rerating,” he says.

More importantly, global trade issues do not affect this investment theme.

“Yes, if a trade war happens, South Korea will be ... affected. But people will soon realise that South Korean banks are doing better and have nothing to do with a trade war. The share prices could rebound faster,” he says.