MLC talks trade tension and market opportunity

Funds Management

by Clive Tompkins

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MLC Portfolio Manager Dr Ben McCaw talks to MLC Research Manager Rebecca Collins about US-China trade tensions, the upcoming G20 meeting, North Korea and implications for Australia.

Rebecca Collins: Hi and welcome. I'm Rebecca Collins, research manager for MLC. And today I'm joined by Dr Ben McCaw, portfolio manager from multi asset portfolios. Thanks for joining us today, Ben.

Dr Ben McCaw: Thanks Beck. Happy to be here.

Rebecca Collins: Great. So Ben there's a lot we could about, but I'd really like to get your thoughts today on what's been happening between the US and China. We've got the G20 coming up at the end of the month. Do you think there's a potential for resolution between these two countries?

Dr Ben McCaw: Well, the way things have been going recently, I think that the chance of a resolution at the G20 has been decreasing, and there's just three reasons for that. The first reason is that there's been an escalation in corporate interference on both sides, and even though you might think that corporate interference is related to trade, it's sort of a little bit outside of that, and that it's pushing the envelope a little bit further than it should be pushed.

The second reason is that both presidents Xi Jinping and Donald Trump, have got some domestic pressures that they need to face into in terms of reaching a resolution. I think that's particularly important on the Chinese side. And then thirdly, you've got to realize that there's just very strong ideological differences between the way these two countries are run, particularly between the two societies. And that's something that's always standing in the way of a deal resolution. But that's more of a medium term issue than a short term issue, but obviously it also affects the short term issues and the chance of a resolution at the G20.

Rebecca Collins: Thanks Ben. So it sounds like there's things to be considering asides from the obvious global growth implications of this erupting?

Dr Ben McCaw: Oh, for sure. And I mean there's the obvious flow on effect, like say the impact on margins in the US because like with any type of tariff issue with when it comes to trade it's unclear where the actual costs are absorbed in a supply chain. They'll be costs absorbed, from Chinese manufacturers. There'll be some cost taken by the Chinese economy through devaluation of the currency. And then there'll be some significant costs spread through the US economy too, both in terms of corporate margins and consumers. Consumers will have to pay more.

But I think like thinking outside of trade, there's something that I worry about that a result of the confrontation between China and the US, and that is that it creates an opportunity for the North Korean Peninsula to flare up again. And the reason for that is that one of the biggest obstacles to the North Korean regime in terms of becoming aggressive is cooperation between China and the US. And at this stage where China and the US aren't cooperating, I think it makes it more difficult for the Chinese to put pressure on North Korea to behave themselves.

Rebecca Collins: Right. So it doesn't sound great in the short term. What about longer-term implications for China and their future?

Dr Ben McCaw: I don't think that this issue, the trade issue has terribly severe implications for the long-term Chinese growth story. And that's because for the past, I don't know, maybe five years now, products from China, Chinese exports of gradually being becoming less and less competitive through time. That's because the demographic dividend that China has been harvesting has diminished through time. Wages have been going up, no productivity gains have been going down, products have been becoming more expensive.

And so a lot of the supply chain has started to make the moves off shore and away from China, particularly into Vietnam and the rest of ASEAN. What the tariffs do is they sort of, they bring forward the readjustment that was going to happen over a long period of time and make that cost pressure get condensed into a short and into a relatively brief period of time. So I think once the Chinese economy steps through this and adjusts, it'll probably end up in a round about the same destination or a round about the same destination it would have ended up any way despite the tariffs.

Rebecca Collins: And China's obviously been a major trade partner for Australia for a number of years. Are there implications for Australia in all of this?

Dr Ben McCaw: I think that depends in the short term anyway on how the Chinese choose to stimulate their economy if indeed they need to. If the Chinese leaders decide that they need a short sharp stimulus, like I they did say in 2008, 2009 and beyond, and there's an uptick in property and infrastructure investment, then the commodity complex will definitely benefit. Commodities are doing well anyway, so they'll just help even more. However, I think that's really unlikely. I think it's much more likely that the China's will concentrate on more social type measures of stimulation, through trying to increase credit, increase consumption because that is the growth story for China at the moment.

And I'm going to judge Chinese economy is trying to deliver. It's not really a a good time to start leveraging up into unproductive type investments into property. So that could be good for Australia, but I think the most important thing for Australia at this point in time is not so much, or especially Australian dollar, is not so much commodities. A lot of people think obviously that commodities are important for the dollar. The thing that's really putting pressure on the Australian dollar at the moment is the intellect differential between Australia and the US.

So in so far as what's happening in China doesn't impact interest rate expectations in Australia or the relativity, I suppose of interest rates in Australia and the US remains [inaudible 00:04:36] Australian dollar won't be too much impacted by what happens in the short term in China.

Rebecca Collins: Thanks Ben. So in all of this are there some investment opportunities for our multi-asset portfolios and the investors in them?

Dr Ben McCaw: There are Beck. Specifically we've had an opportunity to deploy some capital directly into Chinese equities. And like you'd be aware that it's not so much a function of valuation. I think markets right now are sitting pretty much on a 50, 50 trade deal outcome valuation basis. But just because of some of the structural issues in the Chinese equity market at the moment, we've been able to get some capital away in a way that gives us a complete exposure to the upside, but caps a downside at just about at a relatively small loss. Which given the sort of particularly volatile nature of Chinese equities is a very favorable risk return proposition.

Rebecca Collins: Thanks, Ben. As usual, a lot covered today. Appreciate your thoughts. Keep an eye out for what happens with the G20 later this month.

Dr Ben McCaw: Thank you very much, Beck.

Rebecca Collins: And thank you for joining us.


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