U.S., China Finally Sign Phase-One Trade Deal. Here’s What to Look for Next.

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President Donald Trump and Chinese Vice Premier Liu He signed a phase-one trade deal on Wednesday in Washington, D.C., parting at least one cloud that hung over the global economy from a nearly two-year trade war.

 

 

 

Markets have already risen in anticipation of thawing relations between the two countries, since Trump heralded the interim deal in December that included a suspension in imposing another tranche of tariffs. The iShares MSCI China ETF (ticker: MCHI) is up 9.7% in the last month, more than double the S&P 500 index, though the index hit 3290, another record high, on Wednesday afternoon.

 

The deal, which Vice President Mike Pence described in a briefing as a ”new chapter” in relations with China, gives both countries something to walk away with. For President Donald Trump, it’s the ability to tout bringing China to the negotiating table and getting a deal that includes some measure of enforceability and commitments to purchase U.S. agriculture and goods, even if the concessions aren’t of the magnitude initially discussed. For the Chinese, it is the ability to buy some time and not give in to demands for structural changes related to its industrial policy.

 

Here are some of the highlights in the 86-page deal:

* China has agreed to increase its purchases from the U.S. by roughly $200 billion over two years, using 2017 pre-trade war levels as a base. That includes roughly $50 billion in agricultural products, based on market demand, almost $80 billion in manufactured goods—think cars and aircraft, as well as energy purchses and $50 billion of services, including financial.

* China has said it would further open up its financial services sector to foreign investment.

* China agreed to strengthen intellectual property protection, use criminal penalties for those caught stealing trade secrets.

* The deal also requires China to stop pressuring U.S. companies to share technology with local joint venture partners or sell licensing to their technology at below market prices for access to China’s market.

* The deal includes a three-part dispute resolution for enforcement. If disagreement isn’t resolved, the U.S. could resort to reimpose tariffs—an option China also has.

 

To Rory Green, an economist at TS Lombard, the $200 billion purchase commitment in China ramps up imports, making the U.S. more dependent on the China market—meaning the cost to the U.S. economy, if this flares up again, will be even more severe.

 

“This deal provides much needed certainty to American businesses as they begin the new year,” said Thomas Donohue, U.S. Chamber of Commerce Chief Executive, in a statement, adding that it’s critical for both sides to begin negotiations on phase two “as soon as possible” to address significant concerns in the areas of subsidies, digital trade and data discrimination, and non-tariff barriers to U.S. manufacturers and service providers.

 

The comment highlighted what didn’t make it into the phase one deal that Trump touted during a long signing event that included name-checking some of the country’s top executives.

  “We almost had a whole deal but this is a much more targeted and powerful deal. But we will be starting Phase 2 as soon as this kicks on. We are leaving tariffs on,” Trump said at the signing agreement. “They will all come off as soon as we finish Phase Two.

 

The U.S. is expected to tackle thornier issues like cyber-protections, subsidies and state-owned enterprises, in phase-two negotiations.

 

 

What does it mean for investors?

 

The message has largely stayed steady through the twists and turns of the U.S. and China resetting the relationship: Don’t get carried away with short-term good news as this is going to be a long—and likely contentious slog.

 

While the truce removes, at least for the interim, the threat of a trade-related tweet or development swinging markets broadly, tariffs still remain on roughly $360 billion of Chinese goods—roughly two-thirds of what Americans buy from China—for at least 10 months as a means of enforcement for the deal. Average tariffs on Chinese imports will remain elevated at 19.3%—six times higher than before the trade war started, according to the Peterson Institute for International Economics.

 

There are signs of more friction ahead on the technology front as the Commerce Department looks to reportedly eliminate a loophole that would let U.S. companies, through their overseas facilities, sell to Huawei Technologies, a company the U.S. put on its export restrictions list last year.

 

With the strong end-of-the-year run in stocks on expectations of the phase one deal and stabilizing global growth, JPM Asset Management global market strategist Samantha Azzarello says she thinks much of the boost from the signing has already been seen in the market.

 

But corporate confidence may be more grounded in details and based less on optics. “Corporate confidence is more unforgiving. Corporate confidence feels more wary and less trusting of a phase one turning into a comprehensive and smoothly-executed trade deal,” Azzarello says. “Trade policy had become unpredictable and any business leader or capital allocator has to think more than twice before putting money to work through large capex spend or long-term projects in an environment with slower but steady growth and fickle trade and foreign policy.”

When it comes to positioning, Azzarello says she still wants to be tethered to quality stocks and bonds—and for those who can stomach volatility, this could be a good entry point for longer-term investors into emerging market stocks.

 

But with inventory levels low and other signs the global economy could be improving, Conrad Saldanha, manager of the $1.5 billion Neuberger Berman Emerging Markets Equity fund (NEMIX), thinks the interim trade deal could nudge companies to restart corporate spending, as well as feed a more risk-on sentiment that should benefit emerging markets broadly as an asset class.

Potential near-term losers? Brazil and Argentina, which had benefited from the trade war as China found alternative places to buy soybeans, Green says.

 

What’s next?

 

The next developments in U.S.-China tensions may be more sector-oriented, with technology likely to stay in the crosshairs between the two countries. “U.S. concerns over Chinese technology still exist—quite likely we will see this front open up again with further export controls being implemented on Chinese tech companies,” Green says. “China, for their part, is trying to wean their dependency on U.S. tech imports.”

 

As that plays out, Saldanha sees opportunities in Chinese and Asia suppliers to companies like Huawei Technologies that could benefit as the company—and the country more broadly—tries to reduce its dependence on U.S. suppliers. Saldanha says he has been increasingly finding opportunities in Chinese A-share companies, including financials and niche industrials.

 

The Treasury Department this week also issued two final regulations that gives the Committee on Foreign Investment in the U.S. (Cfius) the ability to “better address national security concerns arising from certain investments and real-estate transactions.” That could create more hurdles for foreign investment in the U.S. Already, Chinese foreign direct investment into U.S. industries fell in 2019 to an estimated $3.1 billion—a fraction of the high of $46.5 billion in 2016 but also down 42% from 5.4 billion in 2018, according to a new report by Rhodium Group.

 

Such measures could ripple through to the valuations of technology unicorns, says Winston Ma, former head of North America for China Investment Corp. who currently is an adjunct professor at NYU School of Law. Sovereign-wealth funds, including the one he worked for in China, have been bigger investors in unicorns than venture capital and private-equity funds, which has fueled innovation but also delayed IPOs and led to higher private company valuations and largely passive shareholders, says Ma, who teaches about sovereign investors and regulations at NYU. Cfius and other measures could slow the flow of sovereign money to unicorns, impacting their valuations and governance, he adds.

 

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