Even if US-China tensions are manageable, a rough ride may be in store for listed equities

THE world heaved a sigh of relief when US President Joe Biden met his Chinese counterpart Xi Jinping for the first time in about a year last November in San Francisco, on the sidelines of the Asia-Pacific Economic Cooperation conference.

Even so, the two powers are locked in a fierce contest for global supremacy. In an area such as technology, for instance, each power is trying to develop its semiconductor industry and stifle the other’s growth in the sector.

Crucially, any substantial warming of ties will be difficult, as the two giants operate in different and incompatible systems. 

Moreover, the US may not be comfortable with any challenge to its longstanding position as the sole superpower. Meanwhile, China may want to play a larger role as a leading power in global affairs.

Could competition between two strong players lead to intense conflict that damages both countries and the wider world?

Certainly, Singapore – like many other countries – hopes for US-China relations to be managed well. However, the wishes of other countries for better ties between the giants may matter little if the leaders of the twin powers focus primarily on winning domestic support.

Indeed, both US and China can afford to be fairly inward looking as each country has a large domestic market.

Stability in US-China ties

Things may not go badly awry in a relationship that the US and China manage largely from positions of self-interest. This is even if the US pursues more aggressive pro-American and anti-Chinese positions on jobs and trade – should Donald Trump win the US presidency.

Ultimately, the two powers need each other. Cutting economic ties will be messy and can have huge adverse domestic consequences. The ensuing slower economic growth will hurt jobs and create unhappiness among people. 

If the US and China spend excessive time and energy undermining each other, they risk ceding ground to other countries, which may coalesce to threaten their standing.

As big carbon emitters, the US and China may be forced to find ways to cooperate in fighting climate change or risk facing environmental catastrophes that wreak havoc on domestic economies and living conditions.

The US and China will invariably have spats. Anti-China rhetoric in the US could rise ahead of the US presidential elections in November.

However, there is room for some optimism. While the US-China relationship is fraught with tension, it may be, strangely, somewhat stable because both sides realise that even if they dislike one another, they have to live with each other for a very long time.

Put simply: Strong as each power is, there is little alternative but to somehow get along.

Investors value certainty. A decline in geopolitical risk is a big plus for global equities.

Listed equities

Still, listed equities may be in for a tough ride over the next decade or so.

First, public spending needs to rise to deal with ageing populations. But governments in many countries are already highly indebted. 

Can governments print more money? This may cause a collapse in the currency market. Is there room for fiscal austerity when public services in many countries are already stretched and many people may strongly resist social spending cuts? 

Moreover, servicing debt is costlier with higher interest rates. Risks will rise that countries could default on debt obligations. The contagion effects from countries failing to meet debt payments could cause a global financial crisis.

Second, governments may raise tax rates and introduce new taxes so as to raise revenue to fund public services, upgrade infrastructure, combat climate change and finance national security expenditure. 

Higher taxes can eat into the profit margins and reinvestment capacity of listed companies, as well as curtail their ability to build acquisition war chests and pay dividends. Also, as individuals bear higher tax burdens, they may have less capacity to buy listed equities, thereby affecting market liquidity.

Third, many existing jobs may be destroyed amid the transition to a greener economy and the rise of artificial intelligence (AI).

The wealthy may be able to build sanctuaries to protect themselves from global warming. And talented people could leverage the power of AI to build fortunes.

Still, there might be a large group of people who cannot pivot as jobs are lost due to the rise of AI or the move to a fossil-light economy. And many communities may be ill-prepared for environmental disasters.

Given this backdrop, societies could implode as the population’s distrust of governments and systems rises. In short, domestic political instability can create a treacherous environment for businesses whose investment decisions premised on policy certainty.

Fourth, interest rates could stay fairly elevated amid persistently high inflation.

The days of low interest rates which allowed companies to binge on debt-financed acquisitions or invest based on low-return thresholds are over.  With higher interest rates, investors apply higher discount rates to value future earnings of listed entities – hence the fall in stock valuations. 

In addition, if sitting on cash or investing in relatively risk-free instruments such as treasury bills generates decent returns, there is little to motivate investors to seek higher returns from assets such as listed equities.

Considerations aplenty

Much debate rages over what strategies work in listed equities.

To diversify or concentrate on a few counters; to buy and hold or be disciplined in cutting losses; to time the market or consistently invest regardless of where the market is, are among considerations that investors grapple with.

Importantly, getting capital allocation right greatly affects returns. Unfortunately, even if one sees some stability in the vital US-China relationship, major trends point to an uncompelling investment case for listed equities.