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Investment views

The trade war in numbers

24 July 2019
Author: Michael PowerStrategist

Following the recent release of Chinese GDP figures and economic data from the USA, Michael Power discusses the ongoing trade tensions between the two countries along with a look at global markets.



Lindsay Williams: The Chinese GDP data startled some market participants and some economic analysts and that sort of thing but (I don’t know) I think the 6.2% for the second biggest economy in the world is rather splendid, if you can believe the data, of course. On the telephone now to go through the Chinese data and other matters as well is Michael Power, Strategist at Investec Asset Management in Cape Town.  6.2%, Michael?

Michael Power: The issue ultimately isn’t so much the exact decimal point rather than the direction of the growth. Now we were expecting a slowdown this year and 6.2 for the second largest economy in the world is still not bad. It is still great, actually. I think the interesting thing is going to be is what is going to happen in US growth in the next couple of quarters. You probably have seen the GDP figures from the Atlanta Fed and we are now looking at 1.5% GDP growth in the United States and I have to say a couple of data points in the last few days would suggest that things are not looking so good in the United States.

Lindsay Williams: Yes, the recession that many people have been predicting that might occur in the next 18-24 months is a factor but it seems to be playing itself out quite – I wouldn’t say nicely but it is starting to emerge as a real factor. How much of the Chinese slowdown is due to Mr Trump’s trade war?  It has been going on for a year now, can you believe it, one year of trade wars?

Michael Power: Look, I think we have to understand that China itself wants to change the shape of its economy so, to some extent, it would have been reducing its exposure to export-led growth in any case and trying to reposition itself as an economy that is more driven by domestic consumption and less by foreign appetites and I think that is beginning to happen.

There is every evidence that the Chinese are changing in that regard – their savings rates are inching downwards; their consumption patterns are increasing; the concept of credit is entering into the consumer’s mind.  Yes, they still save a lot but they are not afraid of using their credit cards if they have to. So I think that we are seeing a fundamental change in the Chinese economy and I think that 6.2% growth is probably higher quality if it is more consumption-oriented than 7% would be if it was more export-oriented.

Lindsay Williams: Do you think that the Chinese authorities, the people that matter, are saying to themselves ‘we have been in a trade war situation now for one year with the United States of America; therefore, we have to adapt just in case this carries on’, so therefore they are changing their policies? Any evidence of that because the Chinese are very, very good, from what I understand, at being nimble despite the size of this economy?

Michael Power: Nimble, yes, but also long-term in their thinking and I think that, to be perfectly honest, they accept, whoever was in the White House or indeed (as we are seeing) whoever runs Congress, that life is going to become tougher for the Chinese in terms of their trading relationship with the United States. Some of the Democrats have been saying that Trump is not doing enough – Elizabeth Warren for one.

So I think that the age of ‘Chimerica’ is now over and we are going to see a much more testy relationship between the two moving forward. China, in the meantime, I think is going to reduce its dependence on any tech which might be sourced out of the United States for which a royalty or some such is due if that tech can somehow be interrupted by a presidential order.

The reality is that Huawei is moving very fast, for example, to finish its own operating software for its smartphones by September this year. I heard one (and I have to say this is an unsubstantiated estimate) that they had hired 75,000 PhD’s to finish the process. There is no doubt in my mind that they will have something ready by September. They will probably have to issue lots of patches subsequent but the reality is that, by the end of this year, there won’t be two but three operating systems in the world of cell-phones – iOS for Apple, Android for pretty much everyone else, unless you are Chinese, when you will probably have moved over to Huawei’s operating system. That is just indicative of what the Chinese are going to do – reduce dependence on the technology of outsiders.

Lindsay Williams: Exactly what I was talking about, the nimbleness and their ability to immediately take a situation and say ‘okay, well, this is reality for the next year or so or the next 4 years (whatever it is), let’s do something about it’ and they do so. They don’t get bogged down by bureaucracy. My iPhone is conking out, Michael. Should I be looking elsewhere?

Michael Power: Look, a few months ago I would have probably said if you looked at Stuff Magazine (the UK’s sort of techy magazine which tells you the best tech in the world), you should probably even go all the way over to Huawei but I think that is probably premature now. I think you can probably wait one more time before you think about upgrading to a Chinese phone. I would definitely.

I have at the moment a Samsung and I am very happy with it. As I was saying to you beforehand, all roads lead not to Rome these days but to a cell-phone and having something that is truly versatile – and Samsung is amazing. It beats pretty much everything that Apple can do.  Apple is very much fantastic within its own ecosystem but just doesn’t seem to swim when you take it out of that system and that is something which I think they have fallen behind in all sorts of areas of tech at the moment and I think Samsung is desperate to keep up with Huawei. At the moment, I believe that Samsung’s R&D budget across all its areas is greater than the whole of the Japanese electronics industry put together.

Lindsay Williams: That is extraordinary. We can’t have a discussion about the Chinese GDP without bringing in the United States of America and we can’t bring in the United States of America without talking about the stock market.  One of the pillars of the stock market has been the FANG stocks recently and we had the first real meaningful sign of a crack in the FANG revolution and that was Netflix’s results. I look at this and I say this could be the start of something. What did you think when you saw those Netflix numbers, losing 126,000 subscribers?

Michael Power: Look, I absolutely agree with you. The interesting thing is that the really hard part of those Netflix numbers was that their international acquisition had slowed dramatically. So a lot of Netflix growth was said to be coming from abroad and that has slowed down dramatically.

Now this is something which I think even the Fed Governor has suddenly realised, that the United States is not an island and it will ultimately be affected by what is happening in the rest of the world and I do think the rest of the world is slowing down much more quickly than the United States and this is going to slowly but surely feed through to the United States, either directly or via things like the earnings of Netflix. So, yes, I do think that the FANGs, but for one other reason, they are coming up against a lot of antitrust angst, both in Europe, where it has been for some time, but now even in the United States.  So I think they have got their work cut out for them in the next few months.

Lindsay Williams: I have always been of the opinion that a logistics company, a shipping company, is a very good indicator of future economic growth globally and I am at the moment in Rotterdam and I walk across the Erasmusbrug (as they call it), the Erasmus Bridge across the mighty Maas River and I have been doing that for a couple of years now and I have noticed that the barge traffic going under that bridge has slowed down recently. Maybe it is because it is the summer (I don’t know) but, if there is less stuff being shipped from Rotterdam to other parts of Europe and the world, it tells me that things are starting to slow down. Do you get that feeling as well?

Michael Power: Yes, I do and I think that we are now starting to see results come through in the United States to reflect that in the railway companies, in the freight companies. That is something which I think has always been almost the best leading indicator. CSX (which is probably the one which we should look at most) results a couple of nights ago were so bad that the stock fell 10% and I think that one needs to read the CEO’s report. He said he has never been more puzzled and he is a famously good at delivering earnings growth CEO, probably one of the best in the United States, and his commentary was extraordinary. He said he has never seen a more puzzling market in his history as an executive.

So I think that there are signs of cracks beginning to come through and again to some extent I suppose the freight story will be connected to the trade story but I think that there are signs that there is trouble ahead.  You may have also seen that the New York Fed’s forward-looking indicator with regards to the probability of there being a recession in the next 12 months has jumped to 35%.  It never gets above 50, to be perfectly honest, because by the time we get to the 50, the recession is already there. So we are 70% through that process and the line is almost vertically upwards at the moment. So I think yes, we are likely to have a recession, indeed tellingly, by the time of the next presidential election in the United States.

Lindsay Williams: I wonder what the reaction of the Fed will be. Obviously, it will be to introduce even more quantitative easing, having indicated there could be quantitative tightening this year. So the Fed will step in, do you not think?

Michael Power: Yes, absolutely. I think we are probably set for a half point, not just a quarter point but a half point, at the end of this month.  I would also say the other thing that is worrying me, probably even more at the moment than what is happening in the United States, is the growth of those bonds that are negative-yielding in Europe. This is spreading into 10% of the junk market.  Czech, Poland, Hungary now have negative-yielding bonds. Most of the Club Med countries have negative-yielding bonds. 86% of the bund market is now negative-yielding. This is like a black hole from which the light of no income is radiating and it is something which I think is profoundly worrying and something which most economists or financiers cannot seem to make head or tail of or give a decent explanation as to what are the consequences.

Lindsay Williams: Fascinating stuff, so many things to consider. Michael, thanks so much for that insight. You have given us so much to think about. Michael Power is a Strategist at Investec Asset Management in Cape Town.

Michael Power
Michael Power Strategist

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