Seema Shah
Europe reaches tipping point
Tensions between the US and China are heating up and the European Union is facing increasing pressure to choose a side in the wake of COVID-19. That’s the view of Principal Global Investors Chief Strategist Seema Shah.
“China is increasingly considered a strategic rival to the West. Since China was accepted as a full member of the World Trade Organization (WTO) in 2001, its share of world GDP has jumped from 8% to 19%. Meanwhile, Europe’s portion has fallen from 35% to 16%,” said Ms Shah.
“On one hand, Europe’s relationship with China has profound strategic and economic significance so the EU is understandably hesitant to endanger it. On the other, European leadership recently voiced its disapproval regarding China’s market access and intellectual property theft,” she said.
China remains resilient despite global shift away
Understandably, investors may be worried about China’s evolving diplomatic implications and the deliberate global shift away from China. However, Ms Shah pointed out that both China and Emerging Asia appear to be more resilient than external observers may presume:
“While reciprocal trade tariffs with the U.S. did weigh on China’s economic growth last year—as could similar restrictions with Europe—the impact today may not be as significant as it would have been several years ago. That’s because the Chinese story is no longer about exports.
“Today, about 90% of China’s manufactured goods are consumed domestically. The country’s ratio of exports to overall GDP is lower than many major advanced economies, including Germany, France, and the U.K.—a fact that analysts often seem to overlook.
“China is also funding its own growth. Local investment is driving increased manufacturing capacity, rather than foreign corporations seeking to bolt cheap Chinese labour onto a global supply chain.
“Although additional tariffs could put pressure on the Chinese economy, domestic consumption indicates that China has become less dependent on global trade to sustain strong economic growth,” said Ms Shah.
The rest of Asia hasn’t been standing still
Looking beyond China, Ms Shah said that growth of many developed economies had been parallel to, rather than a result of, China’s growth.
“It’s evident that China isn’t the whole story for Asia. The region has many diverse economies with favourable tailwinds generated by their own rising middle classes, strong political systems, and increasingly sophisticated policymaking tools. Plus, valuations in many of these markets remain attractive, said Ms Shah.
South Korean tech companies, financial services in Asia ex-China and evolving economies in less-developed markets like Vietnam and Thailand were highlighted by Ms Shah as growth markets.
Political interference in capital markets could prove problematic for investors
However, Ms Shah warned of signals of a geopolitical scenario that could fundamentally lessen EM Asia’s investment appeal.
“In the U.S., Congress and the SEC are currently working on guidance that would; force Chinese firms to delist from U.S. stock markets if they don’t comply with U.S. auditing procedures; consider mutual funds that hold Chinese stocks to be failing their fiduciary responsibility; and encourage equity indices to reduce exposure to Chinese holdings because of their lack of financial transparency.
“The clear intention is to convince investors to reduce their investments in Chinese securities. With more than 200 Chinese companies listed in the U.S., representing more than $1 trillion of market capitalisation, political action to limit Chinese access to foreign capital would have significant consequences—not only weakening Chinese investment prospects, but also disrupting EM Asia markets,” she said.
Investors may need to navigate increasingly fraught geopolitical relationships
In conclusion, Ms Shah said there are numerous reasons for investors to maintain strategic exposure to Asia ex-China economies, but also warned of the risks.
“The geopolitical environment carries some material risks. The shifting U.S. political climate may increase the likelihood of governmental interference in capital markets. If it does, investors will need to factor that into their assessment of Chinese stocks and, by inference, emerging markets Asian assets.
“It will be important to keep a close eye on the rhetoric emerging from not just the U.S. and China, but also from the EU, as it works out how to navigate an increasingly fractured relationship,” said Ms Shah.
By Seema Shah