Sino-US trade tensions enter a new phase

17 May, 2019

Ronald Chan, Chief Investment Officer, Equities, Asia ex-Japan

After months of apparent progress in bilateral trade talks, the US unexpectedly raised tariffs on US$200 billion of Chinese imports to 25%, effective 10 May 2019, and added a threat to place tariffs on all Chinese imports¹ . The Chinese government responded by announcing 25% tariffs on US$60 billion of US imports from 1 June 2019² . The escalation in tensions between the world’s two biggest economies has left investors wondering what will come next. In this investment note, Ronald Chan, Chief Investment Officer (CIO) of Asian Equities (ex-Japan), lays out a basic roadmap to help investors understand the possible scenarios that could lead to a resolution of the current dispute.

Escalating trade tensions

After 11 rounds of bilateral trade talks, the US and China have (re)entered a phase of increasing tensions, shattering the calm that settled over the market when both sides agree to refrain from increasing tariffs and continue negotiation in December 2018. However, developments are still in line with our base case; we believe there will be heightened near-term volatility during the Sino-US trade negotiations, but both sides will ultimately reach an agreement and avert a global trade war.

Having acknowledged the increase in trade tensions, we believe there are several constraints on the US and China further upping the ante in the trade conflict. Importantly, additional tariffs on Chinese goods may hurt the US economy, while China’s economy is arguably in a better position than it was a year ago.

US Position: Although the US still operates in a benign inflationary environment, we believe that its position of economic strength has moderated since tariffs were first levied on Chinese goods in June 2018 – GDP growth was 4.2% in the second quarter of 2018 compared with 3.2% in the first quarter of 20193 . The next set of tariffs, due to be placed on a US$300 billion of imports, could impact consumers and retailers more than the previous two tranches. We are likely to see an increase in the prices of consumer goods, lower profits for retailers, and a decrease in disposable income.
China Position: By contrast, China arguably is in a relatively advantageous position than it was last year. The economy is holding up well with a GDP growth rate of 6.4% in the first three months of 2019 – the equivalent number for the second quarter of 2018 was only slightly higher at 6.7%4 , and the government has chosen targeted monetary and fiscal stimulus to bolster economic growth, with further policy measures that can be implemented to help ease any negative impact on the overall economy. These would mainly focus on the consumer. While China’s economy would inevitably be hurt by further tariffs, we believe the Chinese government is acutely aware of the challenges ahead.

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Prospects for a Sino-US trade deal

As trade tensions have entered new territory, we believe it is important for investors to understand the implications and potential scenarios for an agreement.

The first scenario is a trade deal between the US and China, removing the additional tariffs that have been in place since 2018. This is the best outcome for markets, as it would signal a symbolic end to trade tensions and a commitment by both sides to seek a long-term solution. Currently, we believe this is the lowest-probability scenario in the near term.
The second scenario is a trade deal with existing tariffs (include the latest round imposed in 2019) remaining in place. We consider this to be the most probable outcome for a bilateral trade agreement moving forward. Even though this would provide the framework for an agreement, it would still confirm our base-case of continued friction between the two countries.
The third scenario is no trade deal with existing tariffs on both sides remaining in place.
Finally, the fourth scenario is either more tariffs or a breakdown in trade talks. Any further escalation between the two countries, including additional tariffs on imports, would be in this scenario.

Conclusion

While investors are understandably jittery over the latest escalation in the Sino-US trade dispute and the prospect of a global trade war, we believe our initial base-case scenario is still the most likely outcome; near-term volatility, leading ultimately to an agreement. Tariffs will certainly hurt China, but its government does have room to introduce further supportive policies that may offset the negative economic impact of a protracted trade dispute. It could, for example, target domestic drivers such as consumption, which contributed more than 70% to overall GDP growth in 2018⁵ . Equally, the US position of strength has moderated, and the next round of tariffs is likely to hurt domestic consumers and retailers more deeply than the last. Though a deal that removes tariffs is currently the least probable outcome, we believe an agreement that preserves current tariffs and provides a framework for a future pact is more likely than an all-out trade war.

¹Source: Office of the United States Trade Representative, 10 May 2019,

²Source: Ministry of Finance of the People’s Republic of China, 13 May 2019.

³Source: US Bureau of Economic Analysis, as of 26 April 2019. Real gross domestic product (GDP) increased 3.2 % in the first quarter of 2019, compared with 4.2, 3.4% and 2.2% in the second, third and fourth quarter of 2018 respectively. Excluding food and energy, the PCE price index increased 1.6% in March 2019, compared with 2.0% in June, September and December 2018 respectively.

⁴Source: National Bureau of Statistics of China, as of 14 May 2019. GDP increased by 6.4% in the first quarter of 2019, compared with 6.7% and 6.5% and 6.4% in the second, third and fourth quarter of 2018 respectively. The consumer price index increased by 2.5% in April 2019, compared with 1.9%, 2.5% and 1.9% in June and September and December 2018 respectively.

⁵Source: National Bureau of Statistics of China, as of December 2018.

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This website is not intended for use by any individual in any jurisdiction where, due to their nationality, residence, foreign exchange control or other circumstances, the publication or access to this website is restricted or prohibited. It shall be the sole responsibility of the investor to acquaint themselves with, and to comply with, all applicable laws and regulations of any relevant jurisdiction.
Funds offered on this platform may invest in equity, fixed income securities, exchange-traded funds, collective investment schemes and/or other instruments, including derivatives, and each of which has its specific investment objective/ policy with its specific features and different risk profile.
Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Dividend of certain share/unit classes, at the fund or the investment manager’s discretion, may be paid out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share/unit of the respective share/unit classes after the distribution date.
Some funds may invest in bonds or debt securities which may be subject to credit, liquidity, counterparty and market risks.
Some funds may invest in non-investment grade bonds and unrated securities which may be subject to greater credit and liquidity risks, and may be more volatile than higher rated securities. Some funds may invest in investment grade debt securities, which may be subject to ratings downgrades by the rating agencies that may affect the net asset value of the fund.
Some funds may invest in derivative instruments which may involve additional risks. (For example, leverage may cause greater volatility.)
Some funds may make extensive use of derivatives including more complex derivative instruments or strategies to achieve the investment objective, this may give rise to additional exposure in that performance may rise or fall more than it would have done otherwise. In adverse situations, the fund’s use of derivative instruments may become ineffective and the fund may suffer significant losses. The use of derivatives may give rise to leverage, liquidity, counterparty and valuation risks.
Some funds may invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Some funds may invest in securities of small and/or medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Some funds may invest in a single country/region and/or a particular industry sector which may be concentrated and subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
Some funds may have significant exposure to Renminbi ("RMB") bonds/equity/assets or emerging markets, which will be subject to debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with more established markets.
Some funds with significant exposure to RMB bonds/equity/assets may hold a significant portion of assets in deposits if there are not sufficient RMB instruments to invest in. This may adversely affect the funds’ return and performance.
Some funds using Qualified Foreign Institutional Investor (“QFII”) quota to invest directly in debt instruments/shares in Mainland China may be subject to various requirements and restrictions under the laws of Mainland China related to QFII investment and custodial risks.
Some funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
As RMB is not freely convertible, currency conversion is subject to exchange controls and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds with substantial RMB exposure may be more volatile than that of a fund having a more diverse portfolio of investments.
Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
Some funds may invest in Russia and some investments in Russian securities may be unlisted securities not dealt on a regulated market. The Russian market presents specific risks in relation to the settlement and safekeeping of securities.
Investment involves risk. Investors may expose to capital loss and should not invest solely based on the information on this website alone and should read the offering documents for details including the associated risk factors, charges and features of the funds and their share/unit classes. Past performance information is not indicative of future performance.

Manulife Global Fund

Manulife Global Fund is an umbrella fund comprising a number of sub-funds investing in equity and/or fixed income securities, each of which has a different investment objective and risk profile and may involve equity market, geographical concentration, sovereign debt, liquidity, volatility, credit downgrade, interest rate, counterparty risks. Certain investors may also be subject to the risk relating to RMB hedged share class.
The relevant distributing class of the sub-funds does not guarantee distribution of dividends, the frequency of distribution and the amount/rate of dividends. Dividends may be paid out of income, realized capital gains and/or out of capital of certain sub-funds in respect of Inc share class(es). Dividends may be paid out of realized capital gains, capital and/or gross income while charging all or part of their fees and expenses to capital (i.e. payment of fees and expenses out of capital) in respect of MDIST (G), R MDIST (G) and F MDIST (G) share class(es). Dividends paid out of capital of these sub-funds amounts to a return or withdrawal of part of the amount of an investor’s original investment or from any capital gains attributable to that original investment and may result in an immediate decrease in the net asset value per share in respect of such class(es) of the sub-funds. Fixed yield share classes pay out a pre-determined annualized fixed percentage of their NAV, which can be adjusted by the Directors with at least one month’s prior notice, do not entirely reflect the actual or expected income or performance of the Fund. These distributions may exceed the actual income, leading to capital erosion, especially during negative returns or losses, and may reduce future capital growth. A positive distribution yield does not guarantee a positive return, and the absolute distributions vary with the NAV, resulting in fluctuating monthly payouts for investors.
Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
Investment involves risk. The sub-funds may expose their investors to capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds and their share classes.
Each sub-fund intends to use financial derivative instruments (“FDIs”) for investment, efficient portfolio management and/or hedging purposes. The use of FDIs exposes the Fund to additional risks, including counterparty/credit risk, liquidity risk, valuation risk, volatility risk and over-the-counter transaction risk.
Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

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Manulife Advanced Fund SPC is an umbrella fund comprising a number of sub-funds investing primarily in equity and bond securities, each of which has a different investment objective and risk level.
The sub-funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. A sub-fund may at its discretion pay dividend out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share of the respective share classes after the distribution date.
Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Bond Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
Investment involves risk. The sub-funds may expose to a high risk of capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds.

Manulife Hong Kong Series

Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
Certain funds may involve equity market, emerging markets, Dim Sum bond market, concentration, volatility, liquidity, credit, credit ratings, below investment grade and unrated securities, credit rating downgrading, interest rates, valuation, sovereign debt, unlisted debt securities, political and regulatory, currency, foreign exchange, derivative and structured product, hedging, and distribution risks. Certain investors may also be subject to the risk relating to RMB hedged share class..
Certain funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
Certain fund is subject to the risks relating to investment in exchange traded funds, Strategic and Tactical Asset Rebalancing Strategy (“STARS”), small- and mid-capped companies, convertible bonds and the risks associated with securitised debt instruments and investments in loss-absorption features. Certain fund is a feeder fund that invests all or substantially all of its assets in another collective investment scheme (the “master fund”) and is therefore subject to the risks of investing in the master fund.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.

Important notice