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Rising Trade Frictions Spark Concern for China's Strategic Sectors

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Leo Gonzalez

April 21, 2024 - 00:16 am

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Escalating Trade Tensions Cast Shadow Over China's Strategic Industries

In a challenging geopolitical climate, many of China's burgeoning sectors face the increasing prospect of trade restrictions from Western countries, adding a layer of uncertainty to the trajectory of key stocks poised to propel the growth of China's market.

Emerging Threats to Key Sectors

As China vies for supremacy in the green transition and high-tech industries, electric vehicles, wind and solar initiatives, medical apparatus, and chip manufacturing have drawn the concerned gaze of Western powers. These varied industries share a critical commonality: they are integral to President Xi Jinping's ambition to steer China towards environmental sustainability and tech innovation dominance.

The tension escalation coincides with a period that had seen Chinese equities begin to recover from a persistent downturn, spurred by investor confidence in China's dedication to cultivating fresh engines for growth and bolstering self-sufficiency in essential supply chains. Should these Western trade threats come to fruition, they could not only stymie China's international reach but potentially instigate a comprehensive trade conflict that would disrupt the global investment scene.

"Geopolitical pressures are set to intensify — any exports could be targeted as disputes are no longer centered merely around trade equitability," says Vey-Sern Ling, managing director at Union Bancaire Privée. The potential dampening effects on China's export-oriented growth drivers underscore a fundamental concern for the country's economy.

Market Movements Amid Geopolitical Challenges

China's CSI 300 Index has modestly ascended by approximately 3% this year, offering a semblance of relief following a third consecutive year of declines. However, the picture remains mixed for sector leaders in the green and high-tech spheres as concerns about surplus production and price competition are intensified by geopolitical uncertainty.

Battery behemoth Contemporary Amperex Technology Co. Ltd has enjoyed a nearly 17% surge in its onshore share price this year. Meanwhile, electric vehicle forerunner BYD Co. has seen its stock climb by 6%. But not all share a similar fortune; Longi Green Energy Technology Co. and Semiconductor Manufacturing International Corp., for instance, have each experienced a decline of around 20%.

The gravitas of the largest Chinese companies, which derive a minimum of one-fifth of their income from exports, is undeniably substantial in the CSI 300, commanding over a 14% weight. Several of these, including CATL and BYD, command a higher price-to-earnings ratio than the benchmark, data from Bloomberg reveals.

Intensifying Trade Disputes

The landscape of China's relationships with Western nations has been characterized by recurrent trade disputes throughout President Xi's tenure. However, recent developments suggest a heightening of such tensions. The European Union is emulating the U.S. in its protectionist measures, as a confluence of national security, economic, and political factors unfold.

President Joe Biden recently proposed imposing tariffs as steep as 25% on certain Chinese steel and aluminum products, an indication that the rhetoric against China could intensify in an election year. Across the Atlantic, European lawmakers are acknowledging the grievances of local producers who claim to be edged out by China's substantial industrial capacity.

The range of products under scrutiny aligns conspicuously with Xi's prioritized industrial initiatives, otherwise known as "new productive forces." Investors keen on discovering stocks primed for success have been captivated since this concept emerged as a focal point on Beijing's agenda in early March, which sparked a short-lived rally in sectors encompassing everything from robotics to chip production.

The Next Battleground

Attention now turns to which sector might become the next focal point of these disputes. The electric vehicle domain has already attracted scrutiny, with Gavekal Research noting the EU's deteriorating trade balance with China within this industry.

Analysts Cedric Gemehl and Thomas Gatley of Gavekal, in an April 15 note, pointed out the disparity between European and Chinese market cycles, foreseeing the trade balance veering in China's favor. As European domestic demand fortifies, more Chinese goods are likely to be purchased, while the EU's exports to China could stagnate due to feeble demand.

Within China, the lithium battery sector, categorized under clean technology, is predicted by Shen Meng, director at Chanson & Co. in Beijing, to confront increasing challenges. This sector has been an engine of China's export accomplishments in preceding years, with notable companies like CATL, Eve Energy Co., and Gotion High-Tech Co. playing pivotal roles.

Silver Linings Amidst Trade Strife

Despite the pressures, there could be a silver lining as these tensions might expedite China's industrial modernization. Case in point, Huawei Technologies Co., which is unlisted and faces U.S. sanctions, has instigated a leap in the valuation of its suppliers following a technical breakthrough.

"Although the immediate effects of such geopolitical unrest might temporarily hinder specific industries, the enduring consequences could advantage Chinese companies that invest in innovation and adjust to evolving regulatory and market dynamics," opines Tareck Horchani, head of prime brokerage dealing at Maybank Securities Pte.

The contemplation of assorted restrictions will necessitate some time to be enacted. A proposed European investigation into Chinese medical devices acquisition sent prices for stocks like Shenzhen Mindray Bio-Medical Electronics Co. plummeting after the announcement. Nonetheless, many stocks have recouped some of their losses since then.

Conclusion: The Future of Investing in Chinese Stocks

The overarching unpredictability embedded in geopolitical tensions amplifies the risk associated with investing in Chinese equities, a category that already faces investor wariness due to regulatory ambiguities and a decelerating economy.

"Any forthcoming EU protectionist actions aimed at China will further constrict trade and capital influx into the Chinese market, exacerbating the already intense downward force on its equities," asserts Han Piow Liew, a fund manager at Maitri Asset Management Pte. That investing in Chinese stocks during such volatile times necessitates keen acumen and a focused strategy cannot be overstated.

In the complex tapestry of the global economic and political arena, China's strategic industries are at a crossroads. As they contend with the possibility of heightened trade friction, the resilience and adaptability of these sectors may well determine the future trajectory of China's economic ambitions and influence on the world stage.

To read further about Xi Jinping's "new productive forces," which could realign the rebirth of China's economy, please refer to the Bloomberg article here: Decoding Xi’s New Catchphrase Aimed at Reviving China’s Economy.

Additional insights into China's ever-growing dominance of clean-tech supply chains are covered in the BloombergNEF chart, which you can find here: China’s Dominance of Clean-Tech Supply Chains Grows: BNEF Chart.

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