Trade war will outlast Trump, warns Lazard

-- | 11/09/2019

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Lex Hall: Hi, I'm Lex Hall for Morningstar. Welcome to another edition of "Ask the Expert." Today, I am joined by Ron Temple from Lazard Asset Management. He oversees US equities. We're going to talk about the global outlook and how investors should be positioning or repositioning for the turmoil ahead.

Hi, Ron. 

Ron Temple: Hi.

Hall: About 18 months ago, I was writing a piece about the trade war, the burgeoning trade war, and people were sort of shrugging their shoulders a bit and saying, "oh, we are not sure that it will have a particular effect on company earnings, and so on." And now, these days, it seems that every market report you read is based on the fluctuations in the trade war tensions. How do you react to that?

Temple: I think people have underestimated the trade war for the last few years pretty consistently and still today, even in spite of all this attention in recent weeks, months, are still underestimating the severity and the duration of the trade war between the US and China. Not to mention, by the way, we rarely talk about the potential trade war between the US. and Europe as it relates to auto and auto parts. If we focus on China, I do think it is a critically important thing to think about for investors over the years ahead. And I would highlight part of why I say people are underestimating and why I'm more negative on the long-term outlook on China is I think it's evolved from an economic dispute around trade deficits, intellectual property, market access, industrial policy, which you can negotiate, to increasingly be viewed in Washington DC on a bipartisan basis as a national security issue. And put simply, I think, in the US people used to think of China as an economic competitor, but increasingly people are thinking of it as a national security adversary.

And so, with that in the backdrop, what has largely been a story so far of tariffs and a negotiation on economics, is becoming increasingly a story around restrictions on investments in US companies by Chinese companies, restrictions around the trade of technology products. And there's a view again in Washington that we need to curtail the flow of advanced technologies that in any way could be used for military application. So, I think this is likely to continue to deteriorate.

To be very clear, I think we will have periods of time where the pressure rises on the US administration to try to get a deal or to make the markets think a deal is coming. And you might have bits of reprieves here. So, I tend to think of ebbs and flows with a structurally more negative trajectory for this relationship. And I think it will last well beyond Trump administration, whether it's a democrat or a republican replacing them, although the tenor of the conversation might change.

Hall: OK. You go to China a lot. What are people on the ground in China saying about the trade war?

Temple: I think over the last two years, there's been a range of reactions. I think, in the early days, the biggest issue in China was trying to figure out, A, with whom to negotiate, because in traditional times, you would negotiate with the US trade rep or someone from the Department of Commerce. And you might recall, in the early days when China was negotiating, they negotiated with Wilbur Ross, Secretary of Commerce, and with Steven Mnuchin. And then, they found that whatever they had negotiated really didn't hold water because the President didn't accept it. So, there was a question of, A, with whom should we speak? And then, B, if you think about any negotiation any of us ever have, you sit down at the table and you try to think beforehand, well, what is the other side of the table, what are they trying to accomplish? And it's been very difficult for the Chinese side to nail down exactly what the US wanted.

So, again, you might recall in the early rounds, China's offer was to buy more American products, more soybeans, more natural gas. Because I think the view was, well, if we just buy more stuff, reduce the trade deficit, that will solve the problem. But as I mentioned before, since it's evolved, it's very tough. So, I think there's a real challenge of, A, can we really negotiate in good faith with the Trump administration; B, what exactly does the administration want; C, of the list of things they want, what's negotiable and what's nonnegotiable. So, for example, the idea that the US sees China as a military adversary potentially down the road and wants China to basically no longer have access to certain technology is really a nonnegotiable item for China. The idea that the US says the Made in China 2025 initiative is patently unfair, and that the industrial policies are uncompetitive or unfair to foreign competition. Asking China to change its economic system might be a nonnegotiable item if you're advising Xi Jinping. So, I think on that side, there's a real challenge of figuring out how you approach the negotiation and whether you can in good faith reach some kind of agreement.

Hall: OK. While you've got your sort of political strategist hat, kind of, half on, what do you think of the trade war in relation to the upcoming US election and Trump's position? How do you think it will change? China has less to lose arguably in this sense, because it's not running for an election. How do you see that playing out?

Temple: Well, let's take it from two sides. Let's take it from the US side and from the Chinese side. On the US side, it's really interesting in that – I mentioned before the national security view of China is somewhat bipartisan. It's not everyone, but I would generalize it as bipartisan. Interestingly, until the last couple of weeks, none of the Democratic candidates for president have really criticized Trump for what he's doing on China. The primary criticism has been that the approach to addressing the grievances has been counterproductive or unproductive. So, it's more that kind of criticism of means not ends.

In the last couple of weeks that started to change. So, what you've seen is the economic anxiety has been increasing in the business community for over well over a year-and-a-half. It's starting to contaminate or infect the household sector. And we can come back to this later perhaps, but the core anchor to my optimism on the US economy has been a strong household sector, consumer confidence, wage growth, et cetera, that's starting to crack. And in particular, at the late part of August, we got a University of Michigan consumer confidence reading that was the – or maybe this early September – the biggest single month decline in confidence for consumers since 2012 during the Eurozone crisis, and one-third of the respondents volunteered the trade was driving their anxiety.

In the same week, we got a Monmouth political survey. They got headlines because it said five democrats could be Trump. But what was more interesting to me, because I think that headline is really not terribly useful this early in a campaign, was that 37 per cent of voters said that the US economy is on the wrong track and is weakening; 31 per cent said it's on the right track. And that's the first time you've had a negative response since Trump got elected. So, I think if you're in the Trump administration, your anxiety level is increasing as you see a synchronised global industrial deceleration, business confidence going down and early signs that maybe that seeping into the consumer side. And the key for the playbook for Trump to win reelection is economic strength.

Now, on the Chinese side, I think there's also an interesting thing, it's not just the United States that has to decide to reach an agreement. The Chinese have a calculus here. A, if you're Xi Jinping, it's nice not to have elections. Knowing that Donald Trump faces this issue, there should be a real conversation in Beijing about whether China should give the US a deal. So, I tend to try to put myself on both sides when I think about this. If I were advising Xi Jinping, it's actually a bit of a jump ball at this point of do I basically say, let's have the negotiations and keep stringing this along, let's see what happens to his poll ratings. Because this is a man who said within the last couple weeks, if I get reelected, you're going to have an even tougher time getting a deal. Well, then if you're Xi Jinping, and you actually hold some cards here, maybe you want to play the cards in a way that makes it less likely that Trump is the President in 2021. So, I think we should not neglect to think about the Chinese motivations and their leverage because I think China has quite a bit of leverage.

This report appeared on www.morningstar.com.au 2019 Morningstar Australasia Pty Limited

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