US-China trade tensions creating opportunities

-- | 26/04/2018

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Glenn Freeman: In an eventful month so far for markets we have seen trade tensions ramp up and military posturing. But as Andrew Lill from Morningstar Investment Management explains in this edition of "Ask the Expert," they are focusing on the opportunities coming from this while staying mindful of the risks involved.

Andrew Lill: Yeah, well, it looks recently about potential trade wars or potential impacts of tariffs or trade sanctions. So, let me give some key points on that.

I mean, as yet, nothing has been concrete. So, it's all been kind of discussion rather than anything actually changed in terms of global trade. I think the really important thing is that in the U.S. we are coming up to mid-term elections and President Trump knows that a key part of his mandate that he was elected in to do was to effectively look for better opportunities for American companies in the global economic process. And as yet, that's been something that he hasn't been able to deliver. So, I think, there's very much – it's kind of a political factor at this point rather than anything that's actually economic.

I think as a broader topic there, which is that in most cases, leaders tend to focus on expanding the economic growth of their country or the globe. It's certainly been the case for the last two decades of global leaders. But I think as the populist votes start to come to the fore, what's actually tending to happen now is that leaders are focusing on how their country's share of the economic growth bucket can be larger and potentially even at the expense of the overall global economic cycle being smaller.

So, leaders are kind of prepared to trade off a smaller overall outcome for a small win for their particular country. I think that's where Trump is leading with this. And as yet, I think it's negotiation tactics, but I imagine there would try and be a small win, particularly against China prior to the mid-term elections.

Freeman: Now, Andrew, if I can just focus on one of the points you mentioned was how your team is looking for the opportunities these situations create rather than the risks. What are some of these?

Lill: So, I mean, as yet, markets both in the U.S., China, potentially other Asian nations, have been fairly muted in their response to discussions of trade wars. There are a few exceptions. So, there are some of the companies that are in the Dow, some of the biggest sort of multinationals that probably do most of their trade with China, the likes of Caterpillar, 3M, General Electric, Boeing, they are probably being hit a bit harder than the overall market.

So, if you believe that U.S. is going to do less trade with China, then that's just justified. If you think that actually in the end there will be opportunities for those companies just as it was before the trade war discussions, then perhaps they become a bit cheaper. The issue is though, they really haven't come on to our radar as being attractive assets because most U.S. market assets are still quite highly expensive.

Instead, we've been looking at some of the areas of the world that are already cheap and have actually become cheaper. And the Russian equity market has been particularly interesting over the last two weeks where it's fallen by about 10% to its peak at the beginning of April and that's despite oil prices going up to their two or three-year high.

Again, we think that this is perhaps overdone, and the declaration of sanctions has really been focused on one particular person. It's a political factor rather than hitting the hole in the Russian economy.

And we think that outside of the particular one or two companies that are linked to Deripaska, most of the Russian companies look unaffected by these sanctions a lot cheaper than they were two weeks ago. That's a great time for us to think through the uncertainty, to have observed a greater margin of safety in their price to their fundamental earnings and look to increase our exposure, i.e., add assets or buy assets in some of the Russian oil and banking companies.

Freeman: And lastly, the market dip that we saw in response to the missile launch from the U.S. on Syria, is this anything more than a dip or is there something more to it?

Lill: It's really sort of too early to tell. I mean, at this particular point there doesn't seem to be any collateral damage or policy error that came out of that missile strike. It's clear that there are a bunch of nations that are adopting a stronger policy towards both Syria and towards Russia's involvement in Syria. At this stage, we don't see having any impact on fundamental earnings of the majority of the companies that we follow and therefore we will continue to stay invested.

Now, what it is thinking about is, whether that sort of radar of geopolitical risk is either increasing or decreasing. There's always risk out there. You can always find it if you look and really just as a whole we don't currently think that geopolitical risk is any higher than it's been over the last two or three years. So, no change from our point of view.

This report appeared on 2021 Morningstar Australasia Pty Limited

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