Since late 2018, financial markets have had to get used to rising trade tensions between the US and China. Despite ongoing negotiations between Washington and Beijing, the US lifted tariffs on a range of Chinese goods again in May and China upped the ante in response.
What’s causing the trade conflict
The opening exchanges of the trade conflict began in mid-2018, when the US – after months of threats – instituted a round of tariffs specific to China, as punishment for China’s alleged unfair trade practices. China promptly retaliated with its own tariffs on US products.
Despite ongoing negotiations between Washington and Beijing, the US lifted tariffs on a range of Chinese goods again in May and China upped the ante in response.
The US also wants increased access to China’s markets (especially in financial services), as well as a commitment by China to buy more US goods and services. In addition to trade terms, Washington is also seeking stronger protection of US intellectual property, reductions in Beijing’s subsidies to Chinese companies, and greater control over the export of emerging technologies – for example, artificial intelligence (AI), robotics, and quantum computing – which the US sees as sensitive. It does not specify China in these measures, but that is where most observers believe US concerns are directed.
Trade conflict causes uncertainty and losers on both sides
Financial markets have struggled with the trade conflict, says Mark Tierney, global economist at AustralianSuper – in part for the real concerns they have over the consequences for global trade, and partially for the uncertainty that the conflict has engendered.
Tierney says the uncertainty comes largely from the unpredictability of US actions and responses from the Chinese leadership.
There is no winner in a trade war, says Tierney, and there are losers on both sides.
“Chinese manufacturers and US consumers both lose. The impact of tariffs is to raise the price of goods that are imported to the US. Prices are higher, so in theory, consumers will buy less. If there’s less production out of China, manufacturing profits decline and it impacts stock market performance in China. In the US, retailers may sell less of these goods, and their profits and their share prices might decline. It cuts both ways.”
This can potentially flow on to weaker global economic growth, says Tierney – which is what the financial markets fear.
What this means for Australian and world markets
This indirect impact – in financial market nervousness – is what affects Australia the most.
“The crucial thing for Australia is that we are still largely a commodities supplier to China. The argument mainly concerns manufactured goods, and we’re not really involved there. If the trade war continues, the Chinese government will almost certainly stimulate the economy. Under those conditions, Australia suffers only minimal damage. If China’s exports are weakening, it can boost its domestic demand. Under those conditions, Australia will still send a lot of commodities to China, to satisfy that domestic infrastructure and property market,” says Tierney.
The big issue for Australia now, is the policy response by the Chinese government if the trade conflict slows its economy; and more broadly, how global central banks act to stimulate weakening economies.
“The first-round effect is economic growth weakening, and the second-round effect is that business investment globally might also slow under this uncertainty. That could have quite a severe negative impact on the global economy. That’s not evident at the moment, but it’s the major downside risk,” says Tierney.
How has AustralianSuper responded?
In response to the global economic backdrop, Tierney says AustralianSuper has been reducing its weighting to shares in favour of fixed interest over the last year. “We’re holding more bonds than we have for some time, and they have done extremely well. Increasing our exposure to bond markets has helped provide a cushion to the weakness in share markets earlier in the year,” he says.
We also hold a high weighting to unlisted assets, like infrastructure and private equity, which have also contributed to our strong outperformance. AustralianSuper’s Balanced option was ranked No. 1 over both 10 and 15 years by SuperRatings to 31 May 20191. It’s also placed in the top three funds over the 3 and 5 years to 31 May 2019.
“While returns aren’t hitting the double digits, like they have in previous years, performance for the 2018/19 financial year so far is actually quite good.”
AustralianSuper is closely monitoring the balance of risk from a trade and economic downturn, versus the likelihood of central banks and governments using monetary (interest rates) – and perhaps fiscal (spending and taxation) policy to compensate for that.
“We in the investment team are monitoring the situation closely, and fundamentally believe that central banks want to take no chances on growth, so there are potential offsetting actions that should help share markets in the medium term.”Find out more: AustralianSuper’s performance
1. SuperRatings Fund Crediting Rate Survey, SR50 Balanced (60-76) Index 30 May 2019.