Postcards from China

By: BlackRock

BlackRock’s Weekly Market Commentary

Rising trade disputes and U.S.-China strategic tensions are increasingly weighing on global risk assets. How are the frictions playing out on the ground in China? A group of our senior investors recently went on a trip to the mainland to take the pulse on corporate sentiment and potential impacts on global manufacturing supply chains.

Chart of the week

The rising U.S.-China rivalry is casting a cloud over China’s growth outlook. Selling of Chinese equities by foreign investors hit record highs in April and May, with the greatest outflow of foreign capital since the launch five years ago of the “stock connect” program that gave global investors access to Chinese shares through Hong Kong. For now, the Chinese economy appears to be holding steady, thanks to policy support. See the BlackRock Growth GPS in the chart above, which provides a three-month look ahead on the Caixin composite PMI, a popular gauge of China’s economic activity. We see limited direct economic impact of a “no deal” scenario in the ongoing trade negotiations in which U.S. tariffs would be fully applied to all Chinese exports. China likely has the tools to cushion the impact. The more pressing concern is what the escalating tensions imply for the sustainability of global supply chains – and for both Chinese and global companies that rely on them.

The supply chain conundrum

China has evolved from the world’s factory of cheap consumer goods to an integral part of global supply chains for a wide range of products, including sophisticated tech products. The deeply intertwined nature of global supply chains and other mutual interests have contained full-blown escalation between the U.S. and China so far. Yet earnings downgrades across the entire tech supply chain in Asia, particularly in South Korea, Taiwan and Japan, underline investor worries about the long-term disruption brought by rapidly escalating tensions.

Some global companies with large supply chains in China are not going to wait for the next turn in U.S.-China trade negotiations. A sign of the migration already underway: Dramatic wage increases in neighboring, poorer Vietnam as manufacturing jobs relocate there. Yet labor costs are not the only factor when companies consider relocating production facilities. One example: A basic requirement for large-scale manufacturing is a reliable supply of electricity, and many of China’s emerging market rivals fall short in this regard. Adjusting supply chains is a costly affair that companies may have to grapple with for years ahead, in our view. In addition, U.S. firms supplying to Chinese customers face a potential loss of revenues. We also see China’s move toward greater self-reliance – from the tech sector to energy and food production – as likely to accelerate.

Bottom line: We see the direct impact from a fallout in U.S.-China trade talks as limited. And we expect Chinese policymakers to provide support in the case of a downturn, yet are mindful that many policy tools could have unintentional side effects on the economy and markets. Our research on the ground still pointed to confidence in the resilience of the Chinese economy, despite trade talks grinding to a halt. One reason: The credit impulse to the economy is turning positive – a sea change from last year’s clampdown on credit growth. Yet the heightening global trade conflict – including a U.S. threat of tariffs on Mexican goods – is a source of major macro uncertainty globally. This reinforces our call for portfolio resilience, including allocations to U.S. government bonds, which have historically played an important role in cushioning portfolios against bouts of volatility.

Week in Review

  • Global central banks sent strong dovish signals. Fed’s Powell discussed the possibility escalating trade risks could lead to rate cuts at a closely-watched monetary policy conference in Chicago. The European Central Bank committed to leave rates unchanged through the first half of 2020 and has started to discuss additional steps. The Reserve Bank of Australia cut rates for the first time in three years.
  • Global stocks rebounded from a 3-1/2-month low hit in the previous week, boosted by hopes for a Fed rate cut. U.S. tech stocks initially came under pressure on reports the U.S. government had launched its antitrust probes in a few large tech companies. Worries about global growth helped gold, a perceived safe-haven asset, rise to the highest level in more than three months.
  • U.S. job growth slowed sharply and wage rose less than expected in May, suggesting weakening economic growth.

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