Name: Eastworld Spotlight: Face-off between US and China will be negative for the US economy
Uploaded: 2020-08-27
Duration: 13 min 48 s
Description: Jefferies’s Sean Darby talks about how the US-China trade tension will leave to unintended consequences for the US

[MUSIC PLAYING] CLAY CHANDLER: Sean Darby is the Chief Global Equity Strategist at the brokerage Jefferies International, and thank you for joining us today, Sean. SEAN DARBY: Thank you very much for inviting me. CLAY CHANDLER: I wonder if we could begin by talking about Hong Kong, which continues to be in the news. A lot of people over the past year have been lamenting the death of Hong Kong. Hong Kong has been hit by a pandemic. It's obviously been thrown for a loop by this new national security law. And it's in the middle of ongoing US-China trade tensions. And yet the Hong Kong Stock Exchange just announced its results last year, and it's a record profit. What's going on with the Hong Kong Exchange and the markets here? SEAN DARBY: Well, you're quite right. This will be a twin recession for Hong Kong. So both 2019 and 2020, the economy will have contracted. And you're right to point out that we're probably one of the few places in the world that's not only been struck by geopolitical tensions and domestic protests, but also from COVID-19. So it's been a very, very unpleasant picture within the domestic economy. But a bit like the rest of the world, there's been a disconnect between the equity market and what's been happening in the real economy. And part of that's a function, actually, of the US Federal Reserve policy, which has been extremely loose and expansionary, because we are pegged to the US dollar. And secondly, we've benefited from the fact that actually China's economy was one of the first to recover post-COVID-19. So because most of the earnings of the listed companies within the Hang Seng index are generated either in China or overseas, that's also been a reason why you have this very big displacement in the performance of the equity market, despite really near recession levels within most parts of the economy. CLAY CHANDLER: Is that something that you see continuing? What's your outlook for the markets there? SEAN DARBY: Well Certainly we feel that the Federal Reserve policy is going to remain extremely loose. And again, China will be celebrating the centennial founding of the Chinese Communist Party in 2021. So it's clearly got to have the economy doing very well. So in terms of the profit cycle and the external environment for Hong Kong, actually things are still in place to be reasonably good. On the ground, we've been frustrated by a second wave of COVID-19 cases, which has, I guess, pushed back the recovery in many ways. Because there were indications that we were getting very close to opening up our borders, and even hotel occupancy rates had started to recover to the near 50%, 60% level, as people had a staycation. So I think we'll go back to that over the next month or so. And I think really the key litmus test for us is whether we can open the border with Guangdong and the hinterland, or what we call the Greater Bay Area. And if that occurs, then I think we can really say that the end of the recession pretty much was the third quarter of this year. And from that point on we would hope [INAUDIBLE] that the data points in a broad sense were going to actually recover, as well. So fingers crossed, we probably passed worst of the cycle in Hong Kong during this month and last month. CLAY CHANDLER: Going back this question about IPOs just for a second, President Trump was in the news a few days ago saying that the Hong Kong Exchange would no longer be successful, that US had provided all these incentives to it and now was not going to be able to benefit from those. But in some ways it almost looks like just the opposite of what Trump predicted that would be happening. It's that the board of US policymakers are trying to push Chinese companies off of US exchanges. The veterans [INAUDIBLE]. Is that your read of the situation as well? SEAN DARBY: Yes. In the short run, the irony has been that the measures that have been undertaken to tighten the regulations on listings in the United States for Chinese companies, as well as the fact that existing listed companies have to meet much more stringent annual reporting, has actually meant a flock of Chinese companies coming back to Hong Kong to do secondary listings. I think in many ways that was always going to be at some point a part of the travel, or part of the route that China would take in returning a lot of its companies back to the mainland and to Hong Kong, purely for the fact that they were also part of their indices and their economy. So in many ways, Mr. Trump's actions and the actions by the SEC have actually caused that to have sped up very, very rapidly. I think the longer-term issue is that, whether or not there are going to be much more difficult issues for the domestic banking system here in dealing with these counterparts in the United States, or indeed overseas. And that in many ways is still a question mark about how far the sanctions move from the United States towards Hong Kong. Because clearly there could be quite significant downside risks if the US was to prosecute a very, very harsh economic war towards Hong Kong. But you're right, in the short run the irony has been that it's been quite beneficial for Hong Kong to have seen this IPO activity pick up, and also this flock of money coming from the United States to Hong Kong as investors have to reorientate their portfolios. CLAY CHANDLER: I see. So Shanghai and [? Shezhen ?] are the most serious competitors to Hong Kong. But are they going to be able to tap into global capital as long as they're not willing to have the [INAUDIBLE] be fully convertible international? SEAN DARBY: And that's a good question. And you're right, one of the advantages or catalysts for companies to list overseas was to get hold of dollars, number one. And secondly, widen their international shareholder base. Now it's quite fortuitous that as these companies now have to come back and redomicile in mainland China, or indeed in Hong Kong, that actually the investor base in China has itself grown commensurately. So we have to recognize that retail turnover is a very large part of the mainland [INAUDIBLE],, more so than you'd see anywhere else in the world. But it's also becoming highly institutionalized, and even the China insurance companies now can have a weighting in equities above the 35%. So if we had this problem or this tensions between the US and China maybe five or six years ago, I think it might have been a little bit impractical for these companies to quickly come back and reknit, because I just don't think we would have had the depth of the markets in the mainland to absorb such a large amount of capital requirements. But now I would say that that's to be very fortuitous that the depth of the market in the mainland and in Hong Kong has broadened so significantly over the last five years. So to answer your question, I don't think it's going to be an issue getting these IPOs or secondary listings away over the next couple quarters. CLAY CHANDLER: That's an important observation that has really important implications for anyone in the financial industry. I mean, there is always the question about decoupling [INAUDIBLE] the US and the Chinese economies apart. But if it's true that China is developing a more sophisticated financial system, it's pretty hard to just say, oh, I'm not going to compete in that market. SEAN DARBY: That's correct. So despite all of the rhetoric between the United States and China, and certainly the gradual dissolution of the trading relationship and more fractitious comments that are coming through into the US election, China's actually welcomed foreign companies that want to be engaged in the financial industry. Because it does seek a greater depth for its capital markets. And I think in many ways that's not going to change over the next couple of years, because it's very important for China to feel that its capital markets are becoming increasingly important to the mainstream. Because ultimately, they want ensure that the Chinese currency itself becomes part of the mainstream asset class for mainstream means of exchange. So the end game or the long-run view from China is that they should continue to welcome foreign companies participate in their capital markets because ultimately it brings the biggest prize of the RMB becoming more internationalized. And therefore, the economy becomes less dependent on those flows of dollars moving around the system. CLAY CHANDLER: You've mentioned this face-off between the United States and China that really seems to be escalating as we move into the US presidential election in November. One of the flash points of the confrontation recently has been a fresh wave of restrictions announced against Huawei, the giant telecommunications manufacturer. The new wave of restrictions seems to be far tighter and more severe than anything announced against Huawei so far. What implications do you think those new restrictions will have on the company, arguably one of China's largest companies and a key part of it's technology infrastructure? What kind of repercussions do you see from this? SEAN DARBY: You're right. Certainly, we've seen a ratcheting or escalation in the US measures to deal with China, and not just on trade, but on a whole range of issues, including technology. And it's actually quite a complicated way of actually trying to control China's emergence, because there's lots of unintended consequences that can come back to haunt the United States. The first thing to highlight is that you introduce a lot of idiosyncratic risk on corporates globally. Because it is not unthinkable that China itself will set up its own entities list, as the Americans have done so, and restrict the ability of American companies to operate in the Chinese domestic market. So just as we saw with the trade tensions, it's not unthinkable that China also reciprocates in terms of trying to curb the ambitions of American firms on the mainland. The second thing is that these entities that have been targeted in China are huge employers of people within the mainland economy, and there's lots of second round and third round effects, if indeed Huawei or any other Chinese company was to face insolvency. We don't think that's the base case. We think that the Chinese government will backstop these companies. And in fact the domestic economy is large enough to support their activities. So that's one big advantage China does have. The third is that it's only going to force the Chinese authorities to speed up the delivery of local tech components within their own economy. So eventually they won't be as dependent on the United States for their inputs or their products, and that in itself will actually be a negative for the US economy. 

Eastworld Spotlight: Face-off between US and China will be negative for the US economy

International

Trade tensions might have consequences for the US.

US-China face-off could be negative for the US economy

Jefferies’s Sean Darby talks about how the US-China trade tension will leave to unintended consequences for the US