When worlds collide

By far, the most important global risk for equity investors today is the relationship between the US government and the Chinese Communist Party (CCP). Trade is the dimension of the relationship that garners the most press – and rightly so, with President Trump ordering new tariffs on US imports on what is becoming a semi-regular basis. It is not just the dimension of trade, however, that the US is seeking to reshape. The US now views China under the CCP as a strategic rival, with concerns including intellectual property (IP) and technology theft; the militarisation of the South China Sea; and the use of economic and military coercion of countries to gain political influence; not to mention various instances of human rights abuses.

We have written previously about the inflammatory report published by the White House Office of Trade and Manufacturing Policy in June 2018, titled: “How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the United States and the World.” And this came after a very strongly-worded 2017 “Report to Congress of the US-China Economic and Security Review Commission”, which we also reviewed.

In recent days, the US government published its next instalment in the form of the Department of Defense’s “Indo-Pacific Strategy Report” dated June 2019, which also pulls few punches. As with the reports cited above, the Department of Defense uses strongly-worded language to accuse China under the CCP of misbehaving in ways that cannot be tolerated by the US and its allies.

In the report’s opening message, Acting Secretary of Defense, Patrick Shanahan, states that: “The People’s Republic of China, under the leadership of the Chinese Communist Party, seeks to reorder the region to its advantage by leveraging military modernization, influence operations, and predatory economics to coerce other nations.

The report goes on to accuse China under the CCP of undermining the international system from within: “… by exploiting its benefits while simultaneously eroding the values and principles of the rules-based order.” It reiterates previous accusations of cyber theft of intellectual property and technology; highlights the CCP’s use of paramilitary forces with respect to its maritime disputes; and points out that: “China additionally employs non-military tools coercively, including economic tools, during periods of political tensions with countries that China accuses of harming its national interests.”

As stated in this report, the US government categorically believes that China under the CCP: “Seeks Indo-Pacific regional hegemony in the near-term and, ultimately global preeminence in the long-term.” These are very strong words that call into question how the peaceful status quo between the two nations can persist on its current trajectory.

By contrast, the stated US vision is for a “free and open Indo-Pacific”. By free, the US means that: “All nations, regardless of size, are able to exercise their sovereignty free from coercion by other countries.” And by open, the US means that: “All nations enjoy access to international waters, airways, and cyber and space domains, and … fair and reciprocal trade, open investment environments, and transparent agreements between nations.”

Well, apparently two can play at this game. Within days of the release of the US government’s Indo-Pacific Strategy Report, the Chinese government published an English-written whitepaper titled: “China’s Position on the China-US Economic and Trade Consultations”. In this paper, the Chinese government is not being shy as to which side it believes is responsible for the recent break-down in trade negotiations – with their case being made directly to English-speaking readers.

The paper begins by directly refuting US claims of IP and technology theft: “Accusing China of intellectual property theft and forced technology transfer is utterly unfounded.” It also accuses the US government’s recent sanctions on Huawei as being made: “… on the fabricated basis of national security” – a rather hypocritical assertion if ever we’ve seen one.

The paper also makes a number of valid arguments around the mutually beneficial outcomes of free trade and the harmful and counterproductive effects of tariff measures.

But when it comes to breakdowns in trade negotiations, according to the Chinese government, each of these instances was the result of the US government backtracking.

But the more the US government is offered, the more it wants. Resorting to intimidation and coercion, it persisted with exorbitant demands, maintained the additional tariffs imposed since the friction began, and insisted on including mandatory requirements concerning China’s sovereign affairs in the deal, which only served to delay the resolution of remaining differences.

According to the whitepaper: “The US government should bear the sole and entire responsibility for this severe setback to the China-US economic and trade consultations… The US government accusation of Chinese backtracking is totally groundless… In the previous more than ten rounds of negotiations, the US administration kept changing its demands…. [while] China remained cool-headed.

The Chinese government leaves the reader with very little uncertainty as to its position: “China will never compromise on major principles concerning China’s core interests. One prerequisite for a trade deal is that the US should remove all additional tariffs… China will not bow under pressure and will rise to any challenge coming its way. China is open to negotiation, but will also fight to the end if needed.

*     *    *

The recent publishing of these two reports by their respective governments make it clear that the two sides are moving further apart and strengthening in resolve. This means that the probability of any “grand deal” in the near-term has reduced materially. We recently moved our portfolios to be significantly more defensive – along the dimensions of gross, net and composition – on this basis.

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Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.