Our view regarding the recent escalation of trade tensions is that we are just at the start of the process and that the recent market rally yesterday is premature.
Chinese investment of high-tech US companies has been stymied and regulated by CFIUS (Committee on Foreign Investment in the United States). The CFIUS has been strengthened to keep critical security technology out of Chinese hands. This issue here is the Chinese companies involved on these buying sprees are connected to the Chinese state in one way or another.
Alarm over Chinese purchases is not only confined to the US but to Europe as well with the French mostly and Germans expressing concern. For example, French president Macron has called on a unified EU response to the problem. The purchase of Kuka, a leading German robotics company, for 4.2 billion USD highlights these concerns in Europe.
Investment into China requires local partner and that has opened the door to abuse in terms of technology transfer. The lure of the big market is enough for companies to agree on this requirement. WTO rules exist but this is a difficult way to get remedy since it needs to initiated by companies who then might face an indirect retaliation later on in China.
Finally, lets not forget that part of the thinking of letting China into the WTO in the first place was that it would lead to more democracy. The recent doing away with the presidential term limits gives Xi more power that would push China from an authoritarian regime to a dictatorship. Thus the idea that China would be incorporated more into the world system has gone in reverse.
In the addition, we should look at the recent trade actions as part of a broader geopolitical strategy on the part of China and the US. In combination with the ‘One Belt One Road’ or Silk Road project China is seeking to dominate trade under its terms and the recent TPP deal in the rest of Asia was designed as a counter to that strategy. However, Trump did not sign the TPP deal and a trade war has begun.
In short, be prepared for a longer drawn out trade friction especially in the competition of key high tech industries. This dispute also is geopolitical in nature. For example, the ‘One Belt One Road’ project has invested in a 60 billion USD port in Pakistan plus port upgrades in Sri Lanka and the Maldives. This increases Chinese influence in the Indian Ocean. India has countered by leasing a key port in Iran for example.
In our view, the market is too short-sighted here and we expect the trade issue to get worse not better over time. Perhaps in the short term, China will agree just to keep harmony but this have to been done is such a way that Xi does not loose face. Also this will be temporary as I expect China will not give up on obtaining the technology to become the world leader in certain areas.
In light of this, we are keeping a short position on several companies.