China and Emerging Markets – Trump Tariff Losers?
As the inauguration takes place this week, the new administration’s platform pledge of heavy tariffs against China and other nations with substantial trade surpluses with the US takes center stage, negatively impacting many global equities, especially emerging markets. Already rolling over from early October, EM currencies slipped 7.3% over the last three months, and weighed on EM equities, now down more than 10% from the recent October 7th high through January 15th. Obviously, there will be winners and losers in a trade war, but probably not in the way the market expects nor as policy makers intend. Generally, the market’s reaction to the uncertainty, by selling everything EM, appears overdone. While not advocating for a broad increased allocation to EM, and especially not for an increased allocation to China-based investments, we do see pockets of opportunity and believe many select EM investments will show strong results in 2025.
As recently shared in the fourth quarter commentary, for China, we look for geopolitical pressure from the US to continue, adumbrated by President-elect Trump’s tariff increase and other trade barrier intentions. Trump 2025’s policy calls for up to 60% tariffs on Chinese imports. This broadening and intensification of US protectionism, of course, remains troubling from an economic and business perspective, not just for China and the US, but for the global economy in general. If these threats become reality, supply chains will need to adjust. This is not a “new” US trade policy framework since initiated in the first Trump administration, maintained under President Biden, and will likely intensify under the second Trump Presidency. Supply chain reliability and security, disrupted with Covid and new adopted trade barriers, will be a continuing key challenge for global manufacturers. This means intensifying fluctuations in global trade as companies pursue production localization and diversification.
Many believe China will be a loser, with added tariffs lowering US reliance on Chinese imports, thereby weakening the country’s export performance. While this argument has intuitive merit, the historical experience shows something quite different. Despite the imposition of US tariffs in 2018, China’s share of global exports continued to rise for the five years through 2023. Moreover, China has already adjusted for less direct trade engagement with the US, significantly reduced from levels before the first batch of US tariffs. China’s trade with the rest of the world more than compensated, especially with emerging markets, which need China’s materials, technology, infrastructure, equipment, and machines to develop. As EM gradually becomes a bigger part of the global economy, China appears best positioned to benefit. Thus, China already learned how to deal with US trade restrictions over the past eight years. China’s key advantage lies in its ability to offer top-quality products at world-beating prices. Multiple factors drive this competitive edge. First, China holds a commanding advantage in electricity cost. At just $0.078 per kWh, it’s less than half the US ($0.184), approximately 65% less than Japan ($0.221), and almost 80% lower than Germany ($0.365). This means China remains a crucial part of the supply equation for products requiring energy-intensive components such as those created from metals, glass, chemicals, and ceramics, as well as giving China the edge in the rapidly growing, but electricity hungry, AI data center space, where China ranks first in artificial intelligence computing power. Second, in almost all industries, China enjoys a soup to nuts ecosystem. It’s the only country on earth to cover all United Nation’s industrial classifications. This enables a fully integrated production process from raw materials to finished products, including all the supporting manufacturing tools and software. Importantly, in many industries, suppliers geographically cluster, lowering logistic costs and minimizing time to market. Combining this clustering capability with AI, big data, and robotics, the scale advantage amplifies with many Chinese automated production lines running 24 hours a day. Finally, the country’s extensive talent pool offers an advantage in research and development. The country leads in STEM graduates, that is, those with degrees in Science, Technology, Engineering, and Mathematics. No wonder the country’s global patent applications continue to surge. For example, China’s electrical engineering patents accounted for 35.6% of the world’s total in 2023. Truly, China’s manufacturing excellence in such areas as autos, machinery, advanced tools, electronics, and robotics will be an ongoing competitive threat to firms that previously controlled these industries in the advanced economies of the US, Europe, and Japan.
Needless to say, China’s competitiveness will be difficult to overcome, and we’re skeptical of a meaningful manufacturing renaissance in the US, Western Europe, and Japan. That said, we’re also reticent to invest directly into Chinese companies, and our China allocation remains underweight. For one, the geopolitical conflict between the US and China makes investing in China-based companies hazardous. Firms may be blacklisted for perceived relations with the defense sector, and of course, technology hardware firms find it increasingly difficult to source advanced semiconductors as well as the fab equipment to manufacture the chips. To the extent possible, it might be better to stay out of the “firing range” of this brewing trade war between the two superpowers. Not all is lost, however. The opportunity lies in the so-called China Plus One strategy. That is, companies based in other countries that benefit as Chinese firms relocate or partner with companies outside China. This most directly impacts companies in Southeast Asia and India, and has been our focus as we identify companies helping these countries develop the necessary infrastructure and logistics, as well as companies enjoying the associated greater consumer spending as these economies develop.
Of course, the market worries about the widening of the US tariff net, encompassing other countries besides China. Such a strategy could starve US companies of cost-competitive inputs as a large proportion of US imports classify as intermediate goods, integrated into US company supply chains. Raising these import input costs would make US firms less competitive, and import substitution can be difficult or not viable. As indicated above, in many industries, including solar, wind, robotics, rare earth refining, etc., there remains a dearth of alternatives outside China or the China Plus One ecosystem. To place trade barriers universally could damage the US and global economy as well as potentially isolating the US from the global community. Thus, we don’t believe President Trump will impose tariffs on all countries with trade surpluses. This is a long list of countries, twenty-three at last count, and as one former top economist to President Biden stated “…If you put tariffs on every country in the world, it’s not like we can import from Mars…” Yes, global manufacturing will reshape, but this creates opportunities, even a few, in the emerging market world.
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