Investors urged to be patient over China slowdown

Vanguard economist sees reasons to be positive but has long-term fear over US trade war

Investors urged to be patient over China slowdown

The US-China trade spat remains a wildcard for investors but the Far East country has been backed to ride out its slowdown, according to a Vanguard senior economist.

President Donald Trump previously extended a March 1 deadline for increasing tariffs on $200 billion of Chinese goods to 25% from 10% but markets tumbled today after he threatened to raise tariffs further if talks didn't speed up, prompting a sharp sell-off in China. While markets were closed in London and Tokyo because of public holidays, those across the EU also slumped. The Dax in Germany was down 1.8% by early afternoon, while the FTSE MIB in Italy was down 1.9% and the CAC 40 in France was down 2%. 

Qian Wang said that the economic implications of the two countries’ trade war have become increasingly evident, with China’s GDP slowing to 6.4% in the fourth quarter of 2018. It was China’s third successive decline and prompted a series of stimulus measures intended to protect short-term economic stability.

Wang believes that these measures will work and prevent a “hard landing” but that they will take time to work through the economy.

She said: “They may not be as effective as in previous slowdowns, given the elevated leverage in the economy and structural differences in the drivers of this slowdown. Vanguard expects China's GDP growth to be a bit slower than the consensus estimate for the first half of 2019 but to average about 6.1% for the full year; for 2018, it was 6.6%.”

But what impact will this have on the global economy and the markets? Wang believes China has proven its ability to roil the global economy and financial markets despite memories still being fresh from 2015 when Chinese equities fell more than 40% in just over two months and the country lost $1 trillion in foreign currency reserves.

She said: “The relatively good news this time, however, is that the spillover effects through financial channels will be less severe because of capital controls implemented in recent years. These controls reduce the risk of large-scale capital outflows and heightened currency depreciation pressure, such as those witnessed in 2015–2016, and thus help head off a surge in global risk aversion.

“In terms of economic growth, emerging-market countries will be hit hardest by the anticipated slowdown in China. The impacts are expected to be in the range of –0.10% to –0.20% for the United States but as high as –0.49% to –0.64% in Asian and Latin American emerging markets. Japan and Europe will also feel the sting from export-related weakness.”

This growth scare may boost the trade discussion in the short term, with som concessions possible. However, Wang warned that in the long term significant structural issues remain.

She said: “The scope of U.S.-China disagreements extends beyond trade to such areas as investment, technology, intellectual property rights, market access, and industry policy. Although China has expressed intentions to make fundamental structural reforms in these areas down the road, it will be challenging to meet the pace and magnitude of changes desired by the U.S. administration.

“Therefore, the U.S. may use the pressure of further escalation to pursue a later deal on long-term issues. Chinese policymakers will remain on alert and be ready to deliver additional stimulus measures should the situation sour.”