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What I Care About This Week | 2021 Oct 11

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by Franklin J. Parker, CFA

The Summary

The Details

The Biden Administration has tightened many of the tariffs on goods imported from China. Companies and investors who hoped for a change of policy after Trump’s trade war have been quite disappointed. The Office of the US Trade Representative has said it would consider granting tariff waivers for 549 product categories—only about 25% of the number of categories exempted by the Trump administration.

Investors have been dealing with the China trade war for some time. However, it is becoming clear (if it wasn’t already), that decoupling from China is now a bipartisan consensus. I have talked here before about some of the consequences. It might be time to review some of them.

First, and most critically, the Chinese Communist Party (CCP) is not eager to allow US companies to sell goods and services into their consumer market. China is the largest consumer market in the world, so companies unable to operate there face a significant growth ceiling. Apple and Google, to name just two, have made concessions to the CCP in order to be allowed to operate there, but not all companies are willing or able to do so.

Second, China’s manufacturing capacity has been the world’s inflation absorber for the past 30 years. Companies facing higher costs for raw materials and labor have been able to lower costs by sending their manufacturing to China. This has kept consumer prices considerably lower than they otherwise would have been for the past 30 years. A decoupling from China is likely to create upward pressure on prices (some of which we have already seen), though some companies will be able to shift to other places in developing Asia.

Third, China has been as dependent on US businesses as the US has been on Chinese manufacturing. As the two decouple, the risk of conflict escalates. Taiwan becomes a notable example. A few days ago, President Xi announced his desire to seek “peaceful reunification” with Taiwan. US foreign policy with respect to Taiwan has been largely built on ambiguity: neither power is certain what the US would do if China tried to invade the island. With less to lose in a military conflict, the possibility of a conflict, or a proxy conflict, increases.

The merits and demerits of decoupling from China can and will be debated. My purpose here is not to argue for one or the other. Rather, investors should prepare portfolios for the ongoing decoupling between China and the US, and that may turn the tables on winners and losers.

Chart of the Week

I heard a veteran bond manager speak at a CFA event last week. He was quite convincing that 10-year US Treasury yields could reach 3.75% in the near future. While bond investors have mostly insulated themselves from such a dramatic rate rise, equity investors appear to be pretty complacent about this possibility. Many equity sectors could be badly bruised if rates begin to run away. P/E ratios would be the first to contract (which has already begun), but tech and real estate stocks stand to get hurt the most. I would expect other stocks to help make up the difference: namely bank stocks and other financials. Higher rates means more profit for traditional financial businesses.

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