Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team
There has been a great deal of confusion over the past year and a half regarding the exact meaning of many pronouncements coming from the Trump administration regarding foreign policy. The turnover of senior staff, particularly the recent departure of Secretary of State Tillison, has only added to this level of uncertainty.
Despite the short term unpredictability of the administration we remain convinced that they have four clear foreign policy objectives, all of which have implications for our markets of varying degrees.
The first was the elimination of ISIS as a functioning entity. This required the cooperation of Russia given their significant presence in the region. From a market perspective there was very little impact as it was accomplished over a fairly short period of time.
The second objective is to reduce the level of the nuclear threat from North Korea. This has required the cooperation of China, as well as Japan and South Korea. Trump’s initial bluster did worry some in the media, although the markets remained relatively calm. Now that it appears that the possibility of a deal could be reached, the South Korean market, and China plays in particular, have reacted positively.
Our view is that pressure from China on hard currency remittances from North Korea has forced Kim to the negotiating table. This serves China’s interest as their ultimate goal is to prevent the unification of Korea. If there was actually a war, and Trump’s rhetoric regarding Kim certainly got their attention, the end result would certainly be the reunification of Korea under the South’s leadership. For China this remains a very emotional issue. Not only did two million Chinese troops die during the Korean War, they clearly do not want a Western power on their border, especially one with U.S troops present.
The irony is that having moved fairly quickly on North Korea, with the help of the Chinese, the Trump administration has begun to focus on their third main foreign policy objective. This is the renegotiation of trade deals as well as the slowing, and in some cases, elimination of the transfer of certain technologies to China. We view this aspect of Trump’s foreign policy as having the most impact on our markets.
While the renegotiation of NAFTA has been well flagged and discounted by the market, recent moves to raise tariffs on China were unexpected by most observers. Even more unanticipated were the attempts to stop the importation of 5G technology into the Chinese market as well possible sanctioning of the Chinese technology company Huawei.
Our base case has been that we would avoid a trade war, unless we start to see a significant slowdown in the U.S. economy, although this will not be before both sides engage in verbal brinkmanship that could frighten investors. China has made a number of concessions such as reducing tariffs on imported autos that could potentially benefit a number of stocks in our portfolio.
At the same time we remain convinced that the Trump administration is quite serious on the transfer of certain technologies to China, which could have fairly negative implications for specific stocks. Given this risk we would be reluctant to be long those companies that have investments in China which are critically dependent on imported technologies. The good news for many Taiwanese companies is that their government has been well ahead of the U.S. in limiting the export to China of exactly this sort of expertise.
And finally, we believe that the renegotiation or even possible elimination of the Iran nuclear deal is the fourth key tenet of the Trump administration. This is evidenced by the recent appointments of Mike Pompeo and John Bolton to very senior roles. Both have been highly critical of Obama’s deal with Iran. If Trump were to abrogate the agreement then the risk of Iran moving quickly to develop nuclear weapons would become very real. This would have major implications for the oil market as fears would grow that Saudi Arabia would also move to develop their own nuclear capability.
The most effective way for the Trump administration to curtail Iran’s progress would be to enlist the help of Russia. Although this might seem unlikely given the recent implementation of sanctions on Russia by the West, we believe it remains a distinct possibility. It is certainly not possible until the Mueller investigation into possible ties between the Trump campaign and Russia has run its course. If it concludes without implicating Trump then we would expect sanctions to be lifted in a fairly short time period, possibly three to six months, to garner Russia’s assistance on containing Iran. This would not be expected by the market and would have a very positive impact on Russian asset prices.
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