US-China Trade War: How To Navigate The Threats of A Trade War

VIDEO TRANSCRIPT (June 20, 2019 at the NextGen Asia Event)

Prashant Bhayani, Chief Investment Officer, Asia, BNP Paribas Weath Management

Q1 What is your view on the likelihood of a trade war?

That is the trillion dollar question. How we are thinking about it, is scenarios.

First of all, our base case is that trade tensions last into year end, but that there are no further tarifs put on between US and China, allowing time for more talks, but of course it could drag out a bit further than the market expects. 

However the significant minority probability of a trade breakthrough in talks at the end of June or beyond, in the near term.  And thirdly, there’s also a lower probability, but still possible, of a full-blown trade war.

Q2 How will Central Banks react in the second half of the year?

This is another key question. Right now, we expect Central Banks to be somehow pre-emptive, and why? Growth was already slowing more than expected before trade tensions flared up again.

So we saw bond yield drop, and the Fed started becoming more dovish in January, and again more recently in May. So we would expect two interest rate cuts from the Fed, our base case for this year, the ECB (European Central Bank) also become more dovish.

So in general, we expect central banks to be a little bit more pre-emptive, as they are worried about not just trade tensions but also global growth in general.

Q3 How to navigate our portfolio in this kind of environment?

It really depends on your starting point, if you are long of quite a few risk assets, we think that you should diversify.

For example, gold is an excellent portfolio hedge, it’s a deflation hedge, it’s an inflation hedge, it’s a geopolitical hedge.

Structured products are also flexible, they allow you to do principal protection, they benefit from higher volatility.

Thirdly, we also like Asia credit and selective bonds in this environment for income and stable income.

So these are some of the types of portfolio products we would use. Finally, I would call on alternatives, alternatives we think are viable in this kind of market environment, we like for example macro hedge funds which have a low correlation with equities.

Q4 What are the key risks to your view?

So with regards to trade tensions, clearly if there is a breakthrough earlier than expected in the year, which would be great for markets, that would be something that would happen earlier than we expect.

But in that regard, we are neutral equities in the medium term and we don’t advocate going lower than that, so portfolios should still benefit from that breakthrough.

Secondly, central banks, if they are not as pre-emptive, if they are not as dovish, and they wait to see the slow down…in growth, and wait to cut rates, that could lead to a mini growth scare, or even earlier than expected recession and that would go against our base case.

And finally something that everyone’s forgotten about is inflation. Inflation is something which we know right now is under control on our base case as well. However if inflation picks up more than expected for whatever reason late into the cycle, that means the central banks are actually going to be challenged in terms of easing.

Q5 Trade tensions – would there be any beneficiary, especially for Asia?

That’s a good question. We’ve looked at this in depth. And there will be, we think, some trade diversion. 

Asia is probably the biggest beneficiary outside of China of course, from that, in particular the countries we are seeing benefiting the most, number one Vietnam, which is getting significant amount of the lower end manufacturing diversion from China,

In fact, import to the US from Vietnam in the first quarter are up 40%, which is obviously a big number, and that is clearly from trade diversion.

Also parts of North Asia,  like Taiwan, Korea, also benefitted as they are so enmeshed in the technology supply chain, that they also, some trade gets diverted there.

And finally also Malaysia, which also has electronics, and we are starting to see that economy benefiting somehow from some of the trade issues outstanding.