US Protectionism Accelerates China’s Transformation

Although the US’s protectionist stance has added to recent market volatility and elevated trade risks, Citi analysts believe that a full-fledged trade war is unlikely because China has already embarked on a policy path to reduce imbalances.

Citi believes that US protectionist overtures may have accelerated this process, which US President Donald Trump may take to his voters at the upcoming mid-term elections as a show of policy success. In sum, the trade conflict may actually advance globalization – as China becomes more open towards foreign investors.

Over the last 10 years, China has demonstrated that it has become less dependent on trade and more on consumption – particularly online. China’s total trade surplus shrunk from 9% of GDP in 2007 to 1.9% in 2017. Gross exports have fallen from 32% of GDP to 18% in those 10 years.

Consumption now makes up 55% of China’s GDP with online accounting for 20% of retail sales. Among the Chinese e-commerce companies that enable this online consumption, revenue exposure to the US is practically zero – while their revenue growth was 50% year-over-year in 2017.

Citi is positive on Chinese equities, especially China technology. In 2017, the sector’s earnings grew 61% year-over-year - beating expectations by 6 percentage points. While 2018 earnings growth is projected to be down to 17% year-over-year, there may be upside in 2018 as the sector’s earnings per share have grown 38% each year since 2009.

Since the US focused trade tactics on China in March, China’s technology sector underperformed not just the broader market, but also other tech sector benchmarks. Major Chinese tech firms have very little revenue exposure to the US and earnings are growing strongly. As a result, Citi analysts expect a rebound in Chinese tech sector performance.