U.S.-China tensions: beyond tariffs

August 28, 2020 | Frédérique Carrier


We look at the prospects for China’s rebound from COVID-19 and the possible implications of the U.S. elections for investors.

Shanghai skyline

Tension headache

The headlines about U.S.-China trade relations seemed encouraging early this week. Both sides expressed optimism on the Phase 1 trade deal as they held the first direct call between trade officials since the deal was signed early this year.

But despite this progress, U.S.-China relations remain under stress. Two days after the call, the Chinese military fired two missiles into the South China Sea. The move came after China said a U.S. U-2 spy plane entered a no-fly zone without permission during a Chinese live-fire naval drill in the Bohai Sea off its northern coast. The U.S. confirmed a U-2 flight in the region, but said it did not violate international rules.

The sources of friction between both countries are deeply engrained, and the conflict has moved past tough rhetoric. Observers in both the U.S. and China now talk of the potential decoupling of the two countries’ economies, going well beyond the rejigging of supply chains. Recent actions point to attempts to sever more commercial ties between the two countries, particularly in the tech industry.

Citing national security concerns related to the use of U.S. citizens’ personal data, President Trump recently issued executive orders that would effectively ban two highly popular Chinese apps in mid-September. TikTok, a video sharing app, would be banned unless its U.S. operations are sold to a U.S.-based firm. WeChat is a “super-app” used by more than 1.2 billion people worldwide that integrates payment services and e-commerce with messaging to operate like a combination of Amazon, Facebook, WhatsApp, PayPal, and more. Tencent, the owner of WeChat and China’s largest tech company, has filed a lawsuit in the U.S. seeking to block the executive order. Beijing already censors most foreign-operated social media apps.

Key disagreements

Sources of friction

The U.S.'s complaints about China

  • Trade surplus
  • State-owned enterprises
  • Joint venture requirements
  • Intellectual property theft
  • Capital controls
  • COVID-19 origin
  • Hong Kong repression
  • Challenging global order

China's complaints about the U.S.

  • Tariffs
  • Pacific clout
  • Hong Kong interference
  • Control of global order:
    • World Bank
    • World Trade Organization
    • United Nations
    • International Monetary Fund
    • G7

Source - RBC Global Asset Management

Moreover, the Trump administration has suggested it would make it tougher for Chinese companies to be listed on U.S. stock exchanges. Proposals suggest Chinese companies would be forced to delist from U.S. exchanges unless they give American regulators full access to audit them.

There is little doubt that these bans, in addition to other measures taken over the past two years including tariffs and the Huawei ban, would result in economic losses for China. But the measures could also be costly for U.S. firms, which generate some five percent of their overall global revenues in China—an economy that has grown faster than their domestic market for years. In some sectors, such as Information Technology, the Chinese market has grown five times faster than the U.S. market.

Would Biden change the U.S.-China dynamic?

President Trump’s unconventional approach to trade relations has raised tensions with China, but we would not expect a wholesale change in strategy if his administration were replaced in the upcoming elections, as there is bipartisan appeal to being tough on China.

China, for its part, seems to be preparing for years of acrimony, according to RBC Wealth Management Equity Analyst Jasmine Duan in Hong Kong. Perhaps spurred by the recent floods which have devastated a large swathe of the country, authorities recently launched a “no food waste” campaign; this may signal that the country is girding itself for a lasting economic decoupling and attempting to manage its reliance on U.S. agricultural imports.

While the U.S. may maintain pressure on China, we believe further escalation of the conflict is less likely under a Democratic administration. Moreover, the messaging of U.S. policy vis-à-vis China could become more predictable, which could help to reduce tensions. We also see a lower probability that Chinese shares would be delisted under a Biden administration.

Is China’s economic rebound moderating?

For now, China is managing a good recovery from the COVID-19 crisis. Its GDP grew 3.2 percent year over year in Q2, a remarkable bounce after a 6.8 percent contraction in Q1. The figure stood out as the rest of the world reported economic contractions in the same period. China was helped by the fact that it clamped down on the virus earlier than other countries via strict quarantines, as well as by its relatively lower exposure to the sectors most affected by the virus, namely tourism and entertainment.

China’s recovery is the mirror image of that in the U.S., in that China’s industrial sector has shown its resilience as the authorities pumped credit into it, while consumer demand has only partly recovered. RBC Global Asset Management Inc. Chief Economist Eric Lascelles thinks that “each country is playing to its strengths, with the almighty U.S. consumer proving resilient and the legendary Chinse manufacturing base doing likewise.”

But after the initial V-shaped bounce, Chinese economic data moderated in July. Industrial production remained five percent higher than a year previously, though it dropped a little compared to the preceding month. Retail sales also declined, by one percent year over year, after increasing in June. August data suggests the moderation continues.

The worst flooding in decades is affecting up to a dozen Chinese provinces, threatening agriculture and putting infrastructure projects on hold. This should be a temporary impact, and we expect economic activity to pick up after the floodwaters recede.

Lascelles expects that growth will be underpinned by the authorities’ stimulus activity, which has evolved into targeted measures to help selected sectors. He expects China’s GDP to grow by just over one percent this year, and as much as eight percent in 2021 as the economy continues to recover lost ground with support from sustained stimulus. Estimates are fluid, however, and much will depend on flooding, COVID-19, and the evolution of the U.S.-China relationship.

China equities strategy

Chinese equities enjoyed a strong rally from the end of March to early July as the country experienced an economic renewal, but they have been range-bound since as tensions unfurled.

We continue to have an Overweight position in Asia Pacific ex Japan, thanks mostly to China. The country is managing a sound, if moderating, recovery and Q2 corporate earnings so far have surprised on the upside. Valuations are still attractive relative to other emerging markets on most metrics. We would nevertheless have a bias toward those Chinese stocks that focus on the domestic market, given the country’s emphasis on stimulating domestic demand and the risk that a continued antagonistic relationship with the U.S. could give rise to more volatility, particularly in the Technology sector.

Required disclosures

Research resources

Non-U.S. Analyst Disclosure: Jim Allworth, an employee of RBC Wealth Management USA’s foreign affiliate RBC Dominion Securities Inc. contributed to the preparation of this publication. This individual is not registered with or qualified as a research analyst with the U.S. Financial Industry Regulatory Authority (“FINRA”) and, since he is not an associated person of RBC Wealth Management, may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts.

In Quebec, financial planning services are provided by RBC Wealth Management Financial Services Inc. which is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RBC Dominion Securities Inc.