U.S. Treasury Secretary Janet Yellen capped off a weekend visit to Beijing, China, by saying the two nations will continue to engage in economic dialogue despite rising tensions over national security.
VettaFi contributor Dan Mika spoke with Brendan Ahern, chief investment officer of KraneShares, on his optimistic view of the summit.
The following interview has been edited and condensed for clarity.
Mika: What were your top-line takeaways from Yellen’s visit to China over the weekend? And how do they fit into your view of geopolitical tensions between China and the U.S.?
Ahern: With COVID, a lot of relationships were put under a microscope for a stress test. That could lead to positive outcomes like COVID babies. But it also led to a fracturing of many relationships due to a lack of communication, resulting in COVID divorces. I don’t think the U.S.-China political relationship was any different, in that the stresses on the relationship were magnified by a lack of communication, a lack of dialogue, and certainly a lack of meeting in person with one another.
Think about [U.S. Secretary of State Anthony Blinken’s] trip to China, the first time in five years a senior person from the United States political administration met with China. But that positive outcome from the Blinken trip led to Janet Yellen’s China visit, which yielded 10 hours of meetings with a host of senior political and economic officials. That will likely lead to [U.S. Special Presidential Envoy for Climate] John Kerry visiting China very shortly. That is another area where the U.S. and China are very connected. Besides Yellen’s trip on economic relationships, on climate, the U.S. and China have a lot of common views.
Executives Visiting China
Leading up to the Blinken and Yellen trips, it was very difficult not to notice the [many] U.S. and global executives who have visited China recently, whether it’s Jamie Dimon, Elon Musk, or Bill Gates. Why are they going? Well, because they have significant business ties to China.
I think it is understood that the U.S. and China are very connected economically with one another. And as much as the U.S. needs China, it’s true China does need the United States right now, since it is a very significant export partner. At the same time, the U.S. is very reliant on China for a host of goods and services. It’s a huge market and revenue generator for many U.S. multinationals. China is willing to do things that there’s no appetite to have done here in the U.S. China pays a very significant economic consequence for the manufacturing or the processing of steel and rare-earth materials. We basically outsource our polluting to them.
It’s a positive sign that the diplomats and businesspeople have been getting on airplanes and meeting with one another in person.
National Security Issue Dominates
Mika: There’s a recent report that the White House is planning to further limit technology sales to China as a matter of national security. There seems to be this interplay where China and the U.S. have economic ties that they don’t want to decouple from, but at the same time, the discussions about national security from both sides are pitting the countries against each other.
Ahern: The only narrative up until recently has been a national security narrative. I think that narrative has been driven by both sides, and the relationship is certainly multifaceted. Some of this is interesting in that there’s a host of U.S. multinationals that get very significant revenue from China. Those companies do not trade with any sort of beta or correlation to the political news, but Chinese stocks do.
The market seems to be discounting that, from a U.S. multinational perspective, this national security narrative is the only narrative. Apple, Tesla, Starbucks, Nike, Boeing, and Exxon Mobil have significant revenue exposure to China. If the national security narrative was such a dominant narrative, then shouldn’t those stocks be down significantly? They’re telling you that they don’t think that [national security] will be the only narrative involved.
Mika: Moving forward from last weekend’s trip, what do you think investors should be paying attention to, both in terms of ongoing discussions at the intergovernmental level and from corporate executives, over the coming months and years?
Ahern: You’re going to see a likely continuation of dialogue and trips from Chinese officials to the U.S. and vice versa. That will help the relationship.
A Useful Narrative
You have to realize that both sides have used each other, from a national security perspective, to placate or appease a domestic audience. If you’re a politician and you can point the finger over there versus looking in the mirror, it’s a pretty good distraction technique. I think you have to recognize that some of the things that we read are really not meant for [global]consumption. It’s to placate a domestic audience. We don’t talk about a lot of the problems here in the U.S. or with the U.S. economy or about how politicians are distracting us by talking about China. I don’t think we should expect that to go away.
We do believe that you’re going to see more stimulus from China, which will be implemented over the course of the second half of this year, and that’s against the backdrop of very low ownership of Chinese equities by institutional and active fund managers. You have a very significant valuation difference between U.S. tech and Chinese tech. You’re headed into earnings season for Chinese companies in August.
And remember, the second quarter of 2022 had the Shanghai lockdown. The year-over-year comparison for these Chinese equities is going to be an easy bar. And we also have, at the end of July, a very significant economic meeting. The Politburo — the very senior government officials — will meet, and this meeting is focused on the economy. A lot of investors should anticipate articulation of stimulus coming out of that meeting.
Stimulus Likely in China
Mika: On that point of stimulus: Over the weekend, China reported an annualized decline of about 5.4% for PPI and no change in consumer prices. On Monday morning, the Chinese central bank said that it would extend some of the policies it put in place for the real estate sector. Those inflation figures are obscured partially due to global commodity inflation last year from the war in Ukraine. But there’s concerns that China is not quite jumping out of the gate from its COVID lockdowns. What are your thoughts on those prints? How you expect all of this to shape up for additional stimulus to the Chinese economy?
Ahern: China’s going to face the headwind of the global economy slowing. Demand for Chinese exports, inevitably, will slow as the global economy slows. They’re the world’s factory, and there’ll be less demand for those goods. Those export numbers are more reflective of the weakness you see in both the U.S. economy and Europe, for instance. So within the Chinese economy, exports will inevitably slow.
…Historically, China always goes through the infrastructure buildout as part of its stimulus, and that is not happening this time. That’s where a lot of Chinese economists call this atypical, because they’re not going to the traditional infrastructure-driven [stimulus]. You’re not seeing the demand for commodities like we saw coming out of the Global Financial Crisis where they’re building ghost cities, bridges to nowhere, in which you need a lot of steel and copper and cement, right… and thus, PPI is down as well as this lack of infrastructure stimulus.
Domestic Consumption Is Key
So where is the stimulus going to be? You’ve seen some incremental cutting of various interest rates in China, but they’re worried about the currency depreciating too much. That leaves domestic consumption as where they have to really focus. We’ve seen the resiliency of one area where they have articulated domestic consumption support: electric vehicles. The numbers for electric vehicles are exceedingly strong because they continue to extend waiving the tax on EV sales.
You’re seeing the success of one element of stimulus, and then secondly, I think many would anticipate further pro-consumption policies to come out of this Politburo meeting. There’s things you can do to further waive taxes. For example, they have a VAT in China on things like home appliances, so there is an anticipation that we’ll see more policy support.
They’re not running big fiscal deficits, they didn’t do helicopter money or send people free checks in the mail. And so they’ve got quite a bit of dry powder. The consumer in China is coming back — just very slowly and incrementally. They’ve had some scar tissue from the zero-COVID policy, as well as the slowing and decline in real estate prices, where a lot of household wealth is. You want to see consumer confidence build, and that will lead to higher rates of domestic consumption.