Martin Currie: Trade war ‘enhances investment case for emerging markets’ over the long term

Economic offensives between the US and China look set to intensify this year but an all-out trade war will likely be avoided, with savvy investors able to potentially benefit over the longer-term, according to Kim Catechis, head of global emerging markets at Legg Mason affiliate Martin Currie.
Relations between the two powerhouses hit a fresh low on 22 March when the US announced plans to issue new sanctions against China, claiming it was encouraging the theft of intellectual property from American businesses.
US tariffs on Chinese firms could hit $60bn as a result, focused on steel and aluminium imports, exacerbating an already strained relationship and adding to fears of an all-out trade war between the two nations that would hit businesses on both sides. China subsequently hit back with sanctions of its own which could target up to $3bn of goods.
Markets have already reacted around the globe, with sharp falls for key indices. However, Catechis – manager of the Legg Mason Martin Currie Emerging Markets fund – said the trade war could prove to be a good entry point into Chinese equities and other emerging markets.
“Trade and foreign policy tensions between China and the US are likely to intensify by mid-2018, but will likely stop short of an all-out trade war or severe conflict,” Catechis said.
“The threat of $60bn of further tariffs was not unexpected, and the Chinese are on to it and are ready – they have prepared a long list of proportional tariffs to fight back with.”
“Beijing has had a long time to prepare for this and, just like the EU in the recent steel tariffs episode, it has therefore identified a series of products it can target in response to any escalation of tariffs in the US.
“It is therefore already dug in for the long haul and is unlikely to back down, accelerating diversification of markets via its Belt & Road project and other initiatives. The perceived wisdom is therefore that the US has left room to concede, and China has targeted an increase in oil and soy imports, as a way to offer a face-saving de-escalation.”
For investors, the short-term reaction in markets could therefore prove to be an attractive entry point.
Catechis said: “Whilst these headlines may have caused alarm among investors in emerging markets, in the longer term, these trade restrictions will likely only serve to accelerate the rapid growth of intra-regional trade among emerging markets, to the exclusion of the US.
“In our view, this will further shift the gravitational axis of world trade in emerging markets’ favour.”
Catechis said there were three ongoing trade-related developments that could well now accelerate as a result of any US-led trade war.
Firstly, there is RCEP, a new multilateral trade agreement spanning Asia, promoted by China and including India, Japan, Australia, New Zealand, South Korea and the ASEAN countries of South Asia. Together, these countries represent close to 40% of world trade.
Meanwhile, China’s Belt and Road initiative, (the Chinese effort to recreate the Silk Road) is building infrastructure to facilitate trade, and will reach 65 nations. Catechis said it is having an impact on the speed of trade routes between Europe and China.
Finally, the Trans-Pacific Partnership (TPP), the agreement that was negotiated by the Obama administration but ultimately rejected by the White House last year, continues despite the US’ non-involvement. The other eleven countries, including Mexico, Peru, Chile and Malaysia in EM, are pressing ahead regardless
Looking at China specifically, Catechis added there was a clear preference for certain types of company that were exposed to the domestic economy, and in particular to the emerging middle class.
“We see very attractive opportunities in China regardless of the US backdrop, particularly in companies exposed to the growth in the middle-income group of the population, in the areas of private consumption and services,” he said.
The manager also favours internet-related companies that typically deliver high and profitable growth without reliance on external financing.
Longer term, the firms to back are those benefiting from President Xi’s ‘Chinese Dream’ – environmental companies delivering on clean air and water, and services businesses cutting wait times and cost.
Sectors to potentially avoid accordingly are in the ‘old economy’ – heavy industry that is highly indebted, creates significant pollution and tends to operate on thin margins.
“It is a clear choice – the new, shiny, high return on equity economy over the old, polluting, low profitability and high debt economy,” he said.