Five things you need to know about the trade war
SHEILA: Welcome to the J.P. Morgan conference call hosted by David Frame, CEO of US Wealth Management, featuring Cayman Wills, global head of Equities, and Alex Wolf, head of HS Strategy, and former US State Department Economic Officer in Beijing. My name is Sheila, and I will be your conference operator for day. The information discussed today is for informational purposes only. Opinions expressed herein are those of the speakers and may differ from those of other J.P. Morgan employees and affiliates. Neither J.P. Morgan nor any of its affiliates can represent that the statements or opinions expressed today will materialize. This is not an investment research call. The views and strategies described may not be suitable for all investors. And this call is not intended as personal investment advice or as a solicitation or recommendation.
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DAVID FRAME: Okay, this is not Andy. This is David Frame; I'll be your moderator today. And we're excited because not only are we going to talk about something that's very topical, we did not know exactly how topical it would be until a half hour ago, the US decided to delay their tariffs, their September tariffs, so we're going to have that to talk about. The market are responding positively, but what we're going to talk about is where we are in this tariff negotiation, what the core of it is. We're going to spend about 30 minutes total. We shouldn't go longer than 30 minutes, what the implications are of it between China and the US and how that might or might not resolve itself. And then of course the real question is outside of the understanding of the history in the current context, as investor, does it matter? How do we think through putting money to work or staying invested in a period of time of volatility that's being driven by political dialogue that may or may not affect the economic outcomes of the two constituents, the two countries.
So to have that conversation, we wanted to bring two people to talk about the implications. One is Alex Wolf, who is actually based in Hong Kong. And I'd love to get an update from him. He also, as you heard from Sheila in the intro, worked for the State Department, has been very close to US and China negotiations for years, and so I think has extraordinary insight into how this is going to play out. And then Cayman Wills, who runs our equity business globally, and therefore can help us try to interpret market implications. And so the combination of those two should be instructive. And so like I said, we're going to try to get that done in between I guess at this point 25 minutes or so. So I'm going to turn to Alex first. Alex is on the ground in Hong Kong, I guess at this point probably doesn't have a choice 'cause he probably can't get out of Hong Kong given the protests. Alex, just so I - -, the protests, they're affecting life, they're not affecting life? Just give me a sense on the ground in Hong Kong what it's like to be living in a country or a province of a country that is going through such protests?
ALEX WOLF: Yes, they certainly are affecting life, so it really depends I think who you ask. If you've been trying to fly over the last two weeks like I have, you've been affected. If you've been trying to travel on the MTR, which is a subway that's been shut down periodically, then you've been affected. But for the coverage, I think that picked up in Western media of some of the protests, and they have been getting more violent. Those areas that they're in are not necessarily right and central. So where the banks are, where most of the foreign corporations are located, you're not necessarily seeing it.
But that said, they are very fluid. And you used to know what the schedule was. You used to know where they're going to be. But now they seem to be popping up in random locations. And so you could risk just getting caught up in one. And as I mentioned, they have been getting, their tactics have been getting more violent and more aggressive. And so it's definitely, it's definitely affecting life out here. I mean the airport, Hong Kong survives by its airport. It's one of the biggest airports in the world. And so the ability to shut that down day after day is really having a meaningful impact.
FRAME: So as we get through this tariff conversation, I'll definitely want to ask you if we have enough time, how you think China resolves the Hong Kong issue, because obviously they're faced with a conundrum of dealing with the protests or letting them play out, et cetera. So anyway, but let's start with why we got on the phone, which is to talk about tariffs. The US and China seemed to be, seemed to be in a place that was headed towards resolution. I think most market participants thought we were going to get to resolution. The lack of resolution of the last few weeks has stimulated a significant amount of volatility in the markets. I think the market is now grappling with the possibility that there may not be a resolution in spite of today's news. Can you give us a little bit of history from your perspective on is this fighting over something little, is this fighting over something big, and maybe that'll help us understand the possibility of how easy or not easy a resolution would be.
WOLF: Sure, sure. So I'll start by just recapping some of the recent events within negotiations, 'cause I think that’s important and then talk about some of the historical context that has led up to this kind of broader economic conflict. I think you're right. Many people were looking, if you go back to late May, were looking at positive negotiations, very positive tone on both sides, and think that progress was being made. And it was, from everything that I've heard and from all the indications from both sides. There was a lot of progress made on finding a common ground and resolving some of the issues.
But then since early May, things have changed. And the path I think of negotiations since then has been significant enough that we have been looking at changing our baseline from expecting a deal to maybe now looking at more of a prolonged stalemate, more of a frozen compass. And the reason being is that if you go back and you think about Trump's tweet in May where he raised tariffs, just the very public nature of that, it caused a lot of embarrassment for the Chinese, a lot of loss of faith. It made them much less inclined to negotiate.
And then when we saw G20 truce and then talks in Shanghai, and the talks immediately falling apart after Shanghai also caused embarrassment, there was very little trust already between the US and China, and there's much less, if anything, almost no trust left at the moment. And then since then, since we've seen the additional round of tariffs announced. Then we saw China allow some depreciation of currency and then immediately get slapped with what appears to be a very political tag of currency manipulator. Those actions have, those actions as I mentioned have caused a significant I think reduction in trust and significant loss of face, and they just made the Chinese much less inclined to negotiate. They've already said they won't negotiate amid threats. And it made them much less inclined.
FRAME: So let me ask...
WOLF: So there's complete of willingness--oh, go ahead.
FRAME: Let me ask you a question. So this is, let's just say a new way of negotiating with the Chinese. And so your point that the mechanism of dealing with them in a public forum that may lead to their embarrassment and loss of face has made them reluctant to negotiate. In your opinion...
FRAME: Yet we've had 20 years of not reaching an agreement that is being sought now, maybe that's okay or not, in your opinion, is that technique of publically airing the issues with the Chinese, from the US standpoint, is it working even though we're not coming to agreement? Is it not working? Like how does that play out in a negotiation in your mind versus history?
WOLF: Yeah, certainly it's changed tactics. Because in the past, US administrations were very cognizant of making sure that the Chinese leaders could still maintain some face in negotiations. So there is very much a changed tactic. But then you could easily argue that many years of negotiating over IP theft, over the trade deficit, over market access, haven't necessarily been as successful. So I would say on one hand, it definitely has the Chinese very confused. They don't know how to deal with Trump because he's a much different US leader than they've ever had to deal with in the past. And he's far, far, far more unpredictable, which has really put them on the back foot. They're not quite sure what strategy they should take, and they're really playing reaction and catch up instead of this view that China takes is long-term, as a long-term plan and plays a long game. Yeah, it's usually true, but in this case, they're finding that very difficult. So on one hand, it has been a bit disoriented.
On the other hand though, as we approach the election, and I think this is important, as we approach the election, they do understand that a good deal, it could be a win for Trump, could help him get reelected. So it's making them, they're viewing the election as a timeline here, and it's making them less inclined from now to the elections. So that's why I say these tactics in the moment are probably making them less willing to give the US and to give the Trump administration a good deal. So we're getting to the point where the Trump administration, I think the ball is very much in their court. They could accept perhaps a weaker deal to try to get a deal, or a frozen kind of stalemate here. But I think China's probably not willing to meet a lot of US demands at the moment.
FRAME: Okay, so present today's news notwithstanding, do you think the Chinese for various reasons are now getting closer to wanting to wait it out? So as someone who thinks about economic activity, do you think that thus does that affect your view on Chinese output? Does it affect your view on global growth? And then put in context, what exactly, is this just about currency? What exactly is the origin of the conflict intellectually?
WOLF: Sure, sure. So I think the real big question, in terms of your first question on the economic impact, the biggest question mark here is what do we see implemented. On September 1st, how much are the tariffs? So like you mentioned in the recent news, how much is the raise, because so far what we've seen, a lot of it has been priced in. We've already seen suppliers, we've already seen producers deal with it. We're already seeing supply chains adjust. And so it already, it has had a negative impact. You can see it on global trade growth, you can see it on industrial production, on business investment and CAPEX.
The next tranche though is significant, and I suspect that's why the administration is a bit leery about how they're going to follow through, especially now as we go into the holiday season, just because the next 300 billion is mostly consumer goods. And so 10%, I've always said 10% is not that economically meaningful. It can be absorbed a little bit. Currencies can be absorbed. Margins, a little bit of price can be passed on consumers, but 25% would have a meaningful impact. So both on inflation in the US, on consumer prices, on margins, et cetera. So that's why I think we're in somewhat of an equilibrium now at the moment where Trump's probably reluctant to further escalate from here, because it will have a negative, a detrimental impact on the US economy.
But then I think also reluctant to accept a weak deal, which kind of leads to somewhat of our base case. I think for China, we are seeing the negative impacts as well. Trade is a much smaller share of the economy than it used to be, but exports are still 20% of GDP. And exports to US are 20% of total export. So we're looking at about 4% of Chinese GDP. So it's meaningful. And as we see tariffs on Chinese exports to the US increase in terms of total goods, it will continue to have a negative impact.
So go to go your second question now, to recap, I think a bit of a historical context here, which I think is important, it's important to understand why this is such an entrenched problem and also why you're seeing so much frustration I think out of the Trump administration. I usually highlight, it's not just Trump. I think the views of China are much broader amongst the administration. And you have to think about the fact that a lot of civil servants have been working on China policy for many years, across many administrations. I myself worked for Bush a bit and for Obama. And a lot of the people working on these issues are very much the same. And so there's just a lot of deep, entrenched frustration.
And I think why we're seeing what we're seeing now, three real big things have changed. I think US interests have transitioned, which it used to be if you think back under Clinton, especially under Bush, US-China policy was largely driven by the profit motive. It was a view that US business were able to expand production there. They were able to expand sales in China. US businesses were doing too well. And so any time the US wanted to get more hawkish on some of the things that bothered them, and we're talking market access, intellectual property theft, hacking for commercial purposes, unfair trade practices, et cetera, businesses would generally complain, call the White House that they were making too much money. And generally corporate interests dominate US-China policy.
It changed a bit under Obama, where he was much more concerned about international cooperation, having China as a rising power cooperate on especially the Paris climate accord, but a multitude of other issues. And that kind of dominated. Whereas now we're clearly in a different phase where this view of American interests has changed, and we're now less concerned with corporate interests than we used to be, less concerned of course with international cooperation than we used to be. And now we're very much of the view that we're not looking out for free trade but fair trade. That if China is going to have higher tariffs on US goods, we're going to raise tariffs on Chinese goods. If Chinese markets are closed to US firms, we're going to close markets to Chinese firms. It's all about reciprocity.
The second thing that's changed is that I mentioned the business community was largely the ballast maintaining stable tides. They have also changed. So US companies in China now are more vocal, complaining about unfair regulatory practices, refused market access. And so they're actually now asking the US government more or less to push some of their causes.
And a third, which there's a lot of hand-wringing in Washington, and it's hard to say exactly how much of an impact this is having, but there is really a view that China would, that China as it got richer, it would liberalize. The view that as it was more entrenched in the global system, it would uphold the global existing order. And now it's become more clear that in many ways, they're not. They're definitely not becoming more liberal. And in many ways, they're seeking to upturn the existing order of global trade and existing order of global institutions.
And so it's these three things that have really contributed to this changed view in Washington. And what that's resulted in is like I said, widespread frustration. And so why we've seen the escalation that we've seen is that especially in this Trump administration, we've seen a lot of the different government agencies pursue different agendas that they probably always wanted to pursue. You think about the Commerce Department putting sanctions on Huawei or ZTE for business - - in North Korea. You think about the Navy sailing through the South China Sea or sending more military supplies to Taiwan, or the Department of Justice indicting hackers or even arresting Huawei executives.
And so a lot of these different agendas are being pushed in a much more hawkish way, in somewhat of an uncoordinated fashion. And now escalation has somewhat taken on a life of its own. And so it's made it much harder. In addition to what we've seen recently, it's just made it much harder to strike a deal--
FRAME: [Interposing] And so Alex, as we think about, so that's really an interesting kind of look back at the transition in American policy and why it's led us to this point, I asked you this question, I want to end with this so we can go to the market implications with Cayman, but we've got now China threatening if not devaluing their currency, so I can fight you with my currency if I need to. And that may continue. I asked you once before if you were still in the State Department and advising the US administration on what to do, do I make a deal now, or do I let this play out because the issues that you just outlined are too big to not a good deal, and if they didn't think they could get one, like remind of us your answer to that. And do you think that therefore in three months we're going to have another conference call about why this is worse?
WOLF: Sure. So my answer has been that I would advise not taking a weak deal. I think that’s what has happened in the past. That’s - - what China wants. They want to keep the status quo. And I think given the option of pushing harder and potentially causing a bit more economic pain, I think because the US, and we didn't really get to that as much, but the US is more insulated than China. China is much more exposed. They're more exposed to the trade channel obviously, but the US is just not that exposed to Chinese demand. So slightly more insulated from the economic perspective, but I would suggest staying the course. Because I think at a minimum, all of this uncertainty is causing redirection of supply chains, which isn't necessarily a bad thing. It's already even happening anyways.
And I think one of the US goals in this is this phrase that's going around called decoupling, which is just reducing your economic reliance on China, which is reducing the trade deficit that we have with China and maybe spreading the trade deficit out to other countries. And it's also too I think building somewhat of an international - - of some of China's unfair trade practices. And I think the longer this lasts and the more serious the Trump administration shows they are about it, versus just being short-term negotiating tactics, then you're more likely to get actually a meaningful change, potential meaningful change out of China, which is slim, but I think still a chance. So I would suggest, yeah I would suggest staying the course versus capitulating.
FRAME: Got it, so what we've got is we've got a relatively real disagreement between two large sovereigns who are using economic tools of global trade against each other. It feels relatively entrenched, although there's signs every once in a while that we may get a deal. But your point is we may not. The base case is we may not get one this year, and it's I think you said 50/50 as to whether we get one before the next election, right?
WOLF: Yeah, yeah, - -.
FRAME: So therefore that makes Cayman's job really hard, because she has to make a recommendation on investing against the backdrop of uncertainty. Now we can argue that maybe that uncertainty is priced in, in which case great, then we don't have to worry about it. But Cayman, when you think about global equities, let's start with the US, given that's the largest equity market. Is that, how do you go through trying to think through earnings growth and economic activity against the backdrop of what may or may not in a Schrodinger cat sort of way, be a tariff situation?
CAYMAN WILLS: Thanks, Dave. So it's important that when we're looking at the situation, you're not just looking at China and the tariffs. You're not looking at these two items in isolation, because at any time there are headlines or events that can introduce volatility to the markets. And so my job is to make sure we remain focused on the whole picture, the fundamentals. And then based off of that view, determine how to best position portfolios. And so really what is that big picture right now? For the last 18 months, we've been saying we're in the later innings of this cycle. Global growth is slowing. So here in the US, last year we grew around 3%. This year we're likely going to end around 2.5%. Next year we're calling for a base case between 1.5 and 2% GDP growth, which is just right in line with the longer term trend. So we've got slowing growth, slowing global growth. But that does not mean a recession. Plus you also now have 20 central banks globally...
FRAME: I just want to stop you there 'cause that's an important point. When people see volatility and slowing growth, we just lived through '08, it's not just, but it feels like just, people that anticipate wow, as we talked about more recently, I'm not worried about the 5% drawdown that comes with volatility. I'm worried that the next 20% is down. And that would come, most likely I assume you would say with a recession. Is that, what do you think, is that fair, or do you think that that’s the right way to think about it, but we don't think that’s going to happen? Like how do you think that through?
WILLS: I see investors sometimes have that knee-jerk reaction. But what you've got to remember is US earnings are going to be tied to US GDP growth. And so we're calling for trend growth, not accelerating growth here. So again, not a recession, but yes, slowing growth. And so when you take that plus 20 central banks globally that are easing monetary conditions, this provides an important cushion to the cycle and potential future growth. And so we think the cycle can continue. We're probably in like that seventh or eighth inning. And because we've had that late cycle call for already 18 months now, we've already reduced risk in our portfolios. And I'd say today we're in almost a balanced to defensive position. And so to come back to your original question, when it comes to China, we're certainly going to watch the news flow and the data, but we're not changing our call. We're in that defensive position already, and therefore I'm very comfortable with the risk that we currently have in our portfolios. We have exposures in Europe and China.
FRAME: But I assume your point is we'd be a lot more defensive if we thought a recession was coming.
WILLS: That’s exactly...
FRAME: We're not in an anticipated recession mode. We're in a slowing growth mode, which is kind of more of a stable outlook or a slightly slowing, but not one that, you're not worried that tariff escalation causes recession.
WILLS: That’s right. And that we're already in that defensive positioning, which gives me a lot of comfort to ride through potential volatility, especially in August when we tend to see liquidity be a little drier.
FRAME: Okay, and if anyone says all right, I get the fact that portfolios are diversified and stable, and they'll ride through volatility like they always do, and I'm comforted that you don't anticipate a recession from the escalation that may occur, is there anything that you would say is interesting to you? Or is it just stay diversified, ride the course, keep your long-term money aside? Or is there anything that you're like well there are some things that are interesting?
WILLS: So let's start with geographies. In our managed portfolios, we have exposure to Europe, to China. But really where our overweight is, is to the US. So in the managed portfolios as well, what we've been recommending on the more tactical trading side, it's US-focused. But then within the equity allocation, being thoughtful about how you're positioned. And so there we've been really focused on three key things. First is dividends. I love dividends. High-quality companies with strong balance sheets, free cash flow, those that are committed to growing and maintaining shareholder yield. Second is participating with protection and for suitable clients looking at structured notes that give you market exposure, with the added benefit of downside protection. And then the third is secular growth, where no matter where we are on cycle, there are certain long-term trends that we want to be invested in, particularly when you look at the healthcare and technology sector.
FRAME: Long-term meaning two years, five years, ten years?
WILLS: Multi-year, yeah.
FRAME: Got it. So those two are...
WILLS: Those three.
FRAME: Right, but the two, the long-term trends that you identified...
FRAME: Were in what sectors?
WILLS: In healthcare and in technology.
FRAME: Okay. And describe each.
WILLS: Yeah, so within...
FRAME: And hasn't tech already done really well? Is that something I still want to put money to work in? I get the long-term picture, but I get a little nervous when I see how much it's up year to date.
WILLS: That’s the reaction many people have. But when you look at the topline earnings growth, especially coming out of Q2 earnings season, tech continues to perform. So really being exposed to certain pockets of technology where we expect multi-year growth trends, like 5G. Or I've actually really liked talking about electric vehicles, because I think this is a space that's going to be again both that multi-year plus it's already adopting certain trends that we're seeing in consumer behavior and buying patterns. Regulation is getting more and more supportive around the electric vehicle space. As an important point, China has been starting to use subsidies to promote longer range vehicles, higher battery vehicles, installing five million charging stations by 2020. And then also just technology, the cost of technology is coming down, and some of the technology that would be in a self-driving vehicle already in the vehicles we're using today.
FRAME: Got it. And then healthcare, the opposite in terms of it's not performed as well this year. I don't know if that's because, and maybe you can provide some insight, because of concern about government intervention or pricing controls, or other reasons. But you have confidence in spite of its weak performance, just a couple of minutes?
WILLS: Yeah, so within healthcare we want to be exposed to certain subsectors of healthcare. It's not the full, broad brush. So we're looking at those companies that have strong pipelines that are exposed to those diseases that have a large, addressable market like diabetes. And also there are some really great companies that, going back to our yield comment in dividends, that have a strong and stable yield that is competitive to what you're earning in the bond market.
FRAME: Within healthcare.
FRAME: So you get the yield, and if the market goes up, you participate.
FRAME: It helps give you some downside protection, got it. So I guess the crucial question for me is, is this fight between China and the US legitimate? Meaning is it really about things that matter? Sounds like it is. It sounds like it's not going to be as easy maybe as people originally thought to resolve. And therefore we have to anticipate the possibility that it goes on, and maybe escalates. Maybe China devalues their currency more; maybe there's other implications in terms of global tariffs. But your outlook on US growth, while tempered by that, has already anticipated a slowing world, and therefore you're not rethinking that outlook based upon the tariff concerns.
WILLS: That's a perfect summary.
FRAME: Okay, perfect. Well that is your 30 minutes. I appreciate everyone dialing in, thank you so much for your time. Both Alex and Cayman I know spend a lot of time thinking about this and are very appreciative that you gave them the opportunity to share their thoughts and insights. So thank you all for your support and for being clients and giving us your time. Thank you all, have a great day.
SHEILA: Thank you for joining us. This concludes our call. You may now disconnect.
As trade tensions between the U.S. and China mount, markets have become volatile. Serious questions face investors: Does the U.S. Administration want a deal before the election or is “tough on China” the better political path? Will further escalation spell doom for the cycle? Is the Fed’s decision to cut interest rates enough to offset the uncertainty in markets?
Listen to our insights on these topics and more.
Alex Wolf is the Head of Market Strategy for J.P. Morgan Wealth Management in Asia. Prior to joining J.P. Morgan, Alex served as an Economic Officer for the U.S. State Department, stationed in both Beijing and Taiwan. In this role, Alex played a key role in negotiating trade with China on behalf of the United States.
Cayman Wills is the Global Head of Equities, and draws on insights from a global team of market analysts.
David Frame is the CEO of U.S. Wealth Management.
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