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Navigating A Two Block Trade World

Written by Patrick Hill | Aug 28, 2019

“Investors Need to Be Ready for a Two Block Trade World – U.S. and China”

On Bloomberg TV, VMware CEO, Pat Gelsinger, observed that with escalation of the trade war he sees, “two separate trading blocks forming the United States and China, we want to be a player in both and will have to adjustour strategy, investments, supply chains and operations as a result.”  He sees both countries digging in for the foreseeable future.

The evolution of a two trading block global economy has a major impact on how businesses operate in the next five to ten years.  Those with major operations in China that ship products to the U.S. will continue to be adversely affected by U.S. tariffs on Chinese goods. Growing trade headwinds also face, U.S. companies shipping goods to China. Besides tariffs, trade research shows Chinese importers will need to deal with U.S. non-tariff barriers that are not only costly but time consuming.

Here is a list of industry sectors most impacted by the trade war with businesses exports and imports to China:

Sources: U.S. Census Bureau, Marketwatch  – 6/27/19

Major software and electronics companies like Apple, with $56b in sales making up 20% of total global revenue from China, will continue to see declining sales. Apple, and other companies in the same shoes, will have to radically shift supply chains and sourcing for manufacturing.

CISCO, a global network systems manufacturer, recently reported to shareholders a 25% drop in sales of network products to both state-owned and private corporations in China. Many American manufacturers’ source components and sub-assemblies from China which are then shipped to the U.S. mainland for final manufacturing. These supply chains will have to change if they are to sustain profits.

Caterpillar, in the transportation sector, recognizes 10% of global revenue from China and has experienced a significant drop in sales.  Tariffs have significantly reduced soybean exports to China by U.S. farmers to nearly zero. The Federal Reserve in Minneapolis reports farm bankruptcies have reached 2008 levels.

These are just a few examples. Each day the list of impacted industries and companies grows longer.

What does the two block trading world mean to investors?  

The trade war seems to be here to stay. As such, agile CEOs are already planning for the U.S and China to be heavily competing for global trade.  Investors will need to assess the implications for both short and long term investments.

Short term tactical investments:

  1. Research business sectors with major exposure to imports and exports to China
  2. Identify companies with exposure to China trade and related operational vulnerabilities
  3. Identify countries that may act as bridge zones between the two blocks, ie: Australia, Singapore, and Vietnam

Long term strategic investments:

  1. Identify companies that are well-positioned to leverage quickly the now forming two block trading world
  2. Research bridge countries that are making investments in shipping infrastructure and establishing long term trade treaties with both the U.S. and China
  3. Watch the business horizon for new businesses or services that will evolve as a result of the new U.S. – China trade competition

A new global trading structure is forming fast presenting both opportunities and pitfalls for investors.  Agile investors might want to position themselves for optimal growth and income in bridge countries or firms like VMware, where the CEO is moving quickly to establish good relationships with both countries.  

Investors should also consider longer-term investments in Australian based companies or U.S. firms with major operations in Australia as a bridge country.  Many U.S. firms have regional operations headquarters in Sydney.  Sydney, positioned in the Asian region, offers a well-skilled labor force, is an open country to many immigrants from all over Asia that speak and write many languages. Further English is the main language for easy use of technical documentation and recruitment of support staff. The Australian government has been an ally of the U.S. for decades and yet has a bilateral free trade agreement with the Chinese government signed in 2015. As a bonus, the Australian economy has been in expansion for 27 straight years.  The incredibly long string of growth is likely due to a diverse economy, welcoming immigrants who start new businesses, an abundance of natural resources, located at the nexus of Asian growth and a business positive government and culture. It is these same traits that should help them thrive in a two trading block economy.

Investors should be wary of Hong Kong or China-based businesses with American ties that are not politically correct.  The Chinese economy is a state controlled managed economy of state run businesses and private businesses that run under strict guidelines.  Problems in Hong Kong go beyond the present protests. The island city has seen the CEOs of a few local businesses ‘disappear’ when making trips to mainland China. In some instances these disappearances have happened for months throwing the businesses into turmoil and dropping stock prices by 70 – 80%. 

Hong Kong’s future is highly uncertain as the Chinese government is growing increasingly concerned that democracy might ‘leak’ to the mainland and thereby threaten authoritarian rule.  The Chinese government has announced the development of an ‘entites’ list of U.S. companies that Chinese firms are not to do business. American firms affiliated with these targeted firms will see significantly reduced sales. On the U.S. side, the Trump administration has gone back and forth on suppliers to Huawei and is now writing a ‘blacklist’ of Chinese firms that American companies are to end business with. Smart investors will need to keep track of U.S. and Chinese government pronouncements and policies in regard to which companies are ‘in’ and which are ‘out’. These may change by the day or week.

Monitoring markets or executive behaviors that are likely to catch government scrutiny will offer investors an early warning of which firms may soon appear on the lists. One possible new sector of scrutiny are cybersecurity companies, which provide both countries an edge in the digital economy. Both countries will want to maintain control, access and future development of digital security power.

The two trading block global economy will require careful research, constant monitoring, and quick moves as politically ‘in’ companies can become ‘out’ at the whim of government leaders in both countries.  Investments in stable countries, with firms that have a long history of bridging their business between both China and the U.S. are likely to be the best investment opportunities over the long term. Note that in any global recession, these bridge countries and companies are likely to be the first to recover from a recession.

Patrick Hill is the Editor of The Progressive Ensign, https://theprogressiveensign.com/

writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.


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Patrick Hill

2019/08/28
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