Assessing Investing Impacts of the Great Decoupling

JUNE 08, 2020
David Robinson, CFP
investingWe are now witnessing the beginning of the end of the Chinese economy—and of US-China trade—as we know them. Developments leading up to this have been under way for years, but the shift is now being catalyzed by geopolitical tensions stemming from the coronavirus 2019 (COVID-19) pandemic.

The shift will ultimately have a transformational impact on American investment markets, some American companies and various investment funds. Investors who get their arms around the situation sooner rather than later and assess potential impacts on their portfolios will be better able to limit damage and position to benefit.

Signs of the shift have been evident for years. China became the planet’s second-largest economy (though one with sharply declining gross domestic product before the pandemic), from decades of cash infusions from large American companies seeking a cheap place to manufacture. But the Chinese communist government has long flouted the corporate partnerships it approved by setting up competitive entities and committing flagrant patent infringement, much to the bipartisan displeasure of the US government and the dismay of the US companies financially damaged. And in recent years, costs of manufacturing in China have risen considerably. Now, the virus’ impact is awakening American companies with manufacturing operations in China to the need to site plants friendlier places.

Also, noted J. Kyle Bass, founder and CEO of Hayman Capital Management, a Dallas-based hedge fund—and a widely-quoted expert on China’s financial impact—the shrinking Chinese economy has become highly leveraged and hence, unstable. Among other experts, Bass has focused renewed attention on the long-overlooked situation wherein the U.S. and other leading Western democratic nations have relied—exclusively in some markets, such as blood-pressure medication—on the supply chains in a communist nation with an appalling record of human rights violations.

Because of the Chinese government’s actions as the virus spread—issuing propaganda and refusing to cooperate with the West--there’s growing support for Western nations to seek reparations. “There’s a tide of resentment toward China over the virus in the West, including the US, Canada, Australia and the UK,” said Bass. But this would likely result in a stalemate, considering the various implausible counter-narratives on the virus’ origins that the Chinese government is pushing. 

In recent years, U.S.-Chinese tensions have run high over various other factors, including the ongoing trade war and China’s territorial claim that the entire South China Sea belonged to it—and its construction of islands there, presumably for strategic military purposes.
  
Regarding multinational manufacturing in China, the virus has accelerated what’s becoming known as the great decoupling of the 2 nations. “As bad as the tech war between the U.S. and China [already] had the potential to become, there was worse yet to go as this split spilled into other economic areas,” says Ian Brenner, president of the Eurasia Group. “Coronavirus has sped up that timeline considerably; manufacturing and services sectors have already been forced to begin reorganizing supply chains and staff.”

US-Chinese financial friction is at the highest point in decades. This scenario, heighted by issues over the pandemic, involves these developments:
  • China’s continued reach into Hong Kong, seeking to curtail its autonomy and ultimately take control of the city-state. These moves, met by protests in the streets in Hong Kong, are ratcheting up tensions with US because of American interests in sustaining the island as a democratic state.
  • The Senate’s approval, in late May, of sweeping Trump- administration-backed legislation seeking to bar 156 Chinese companies now listed on US exchanges, and from other means of raising money from American investors, if they don’t comply with rules including those requiring them to submit to required audits conducted by the Public Company Accounting Oversight Board, the nonprofit entity that oversees audits of all US public companies. 
  • Sen. Lindsey Graham’s proposing legislation, in late May, that would allow President Trump to impose sanctions on China if it doesn’t transparently investigate the origins of the pandemic.
  • The acceleration of existing plans by Google and Microsoft to shift production from China to Southeast Asia—Vietnam and potentially Thailand. Until now, most, if not all, Google smartphones and Microsoft computers have been made in China. Also, reports surfaced in May concerning Apple’s plans to potentially move manufacturing from China to India.
Generally, with these developments in mind, investors should take a hard look at their portfolios and consider potential impacts. Specifically, investors should:
  • Assess the degree of China and China-related exposure in their overall portfolios.
  • Determine whether they directly or indirectly own shares of any of the 156 Chinese companies targeted in the Senate bill, and assess the potential risks from de-listing—for companies that fail to comply with the legislation’s requirements (assuming it passes the House).
  • Prepare for the impact of a likely end to Chinese companies’ advantages from their longstanding status as emerging market companies. An end to emerging status would mean that these companies would basically have to compete on a level playing field for investment dollars, which could lower asset values and have a major impact on international funds.
  • Evaluate the ultimate impact that the developing China supply chain rerouting will have on U.S.-based multinational companies, particularly those in tech, pharma and precious metals. Within these sectors, what companies are best or worst positioned to shift supply chains? And with what degree of business interruption?
  • Assess the investment potential of the indirect benefits of the trade shift for Southeast Asia (Vietnam and Thailand) and the Indian subcontinent (India and Bangladesh). Might this lift investments in these emerging markets?
If US-China relations were to suddenly warm up, the trade war were to end, the 2 nations were to bury the coronavirus hatchet and American multinational companies regained confidence in siting plants in China, this would be nothing short of a miracle. It seems only logical to consider investing in the other direction.

David Robinson, a Certified Financial Planner, is founder/CEO of RTS Private Wealth Management, an SEC-registered firm in Phoenix that provides fiduciary services to help clients achieve their financial goals. His practice focuses on helping wealthy individuals with custom financial plans, using a holistic approach to grow/protect wealth, manage taxes, identify insurance solutions, prepare for retirement and manage estate plans.

The views expressed in this piece reflect those of the author, not necessarily those of the publication.

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