Wealth Insights | Weekly Market Analysis | Economy/Politics
Weekly Market Analysis - G2 Polarization – Eyeing China’s Response to US Policy
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Election Uncertainty to Weigh on Investor Sentiment
The second US presidential election debate took a far different course than the first. Both candidates were sure to cite Chinese, Russian and other foreign factors as material threats for the US. We see US election uncertainty dragging on investor sentiment, following the routine but temporary pattern of election years we discussed in last week’s CIO Bulletin.
Policy Changes May be Muted
Whether the coming US election unifies Congress and the Executive branch under one party or leaves it divided remains highly unpredictable in our view. For US fiscal policy, we see significant constraints on major tax and spending policy changes compared to the elections of 2016 and 2020, regardless of who wins.
China’s Response: To Look and Invest Within
This week, we reexamine China’s challenges which are impacting global markets. Rather than stimulate weak demand, China has chosen to invest in its own supply chains, focusing on their future security. This follows US steps to limit technology transfers.
Summary
After a second presidential debate, news coverage of the US election is set to heat up further in coming weeks. The temperature is set to “boil.” As the world watches anxiously, Tuesday’s debate showed apocalyptic language has been normalized.
In matters such as foreign policy and regulation, the differences between candidates Harris and Trump shouldn’t be minimized. With Federal Reserve interest rate cuts coming and a very strong US dollar as a starting point, the pressure to “absorb pain” is absent. And once feared as a “ticking time bomb,” China’s holdings of US Treasuries have diminished to less than 3% of US borrowing. While its financial linkages to the world remain very limited relative to its size, its impact on global trade and corporate profits remains enormous.
Portfolio considerations
- The world is waiting on the US election to understand its foreign policy course which will take a very different turn under Harris or Trump. G2 polarization – a division of alliances around the US and China – seems to be significantly steering Chinese economic policy.
- China’s concern with security and self-sufficiency is likely driving a less robust domestic stimulus approach. This allows deflationary dynamics to fester. In contrast, tight fiscal policy is far off from the US political agenda.
- Among the greater US domestic tax uncertainties, the halving of the US estate tax exemption in 2026 under current law may provide a good motivation for planning.
Source: Haver Analytics, September 11, 2024. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.
Election Uncertainty to Weigh on Investor Sentiment
Even after the Harris/Trump debate, current US presidential polling shows a close race. The much larger number of Senate Democrats facing re-election in November than Republicans (roughly 3 to 1) suggests a higher probability of a Republican “red sweep” if Trump wins the presidency than if Harris wins for Democrats. One prediction market shows an 80% chance of a Republican Senate win. However, polling data also suggests a solid chance that the closely divided House of Representatives swings to Democrats. In short, we see the chance of a divided government of some sort (with either house of Congress or the Presidency differing in party) at slightly above 50%. A divided government would be forced to compromise on US fiscal issues that demand attention, limiting the scope for aspirational changes.
Policy Changes May be Muted
It would take an act of Congress to raise corporate taxes, dividend income taxes or put new wealth taxes into place. Using so-called “reconciliation procedures,” a unified government could approve such changes without a filibuster-proof super-majority of 60 Senate votes. Yet since the chance of a Democrat “blue sweep” seems quite low even if Harris wins the Presidency (see above), we see the probability of any new forms of taxation or radically higher tax rates as low.
China’s Response: To Look and Invest Within
China’s economy may now be performing worse than official data suggests. Survey data suggest that industrial production is slower than the reported 5%. Deep property declines and weak manufacturing suggest fixed investment might be negative, rather than the 2% pace reported. Retail sales growth at 2.7% also seems high compared to the unemployment rate and confidence measures. This could also mean that we’re closer to action from officials. Real GDP growth of 4.7% Y/Y in 2Q shows weak momentum with more action needed to restore growth to meet the 5% target.
But it is important to understand why China has taken the policy steps that it has over the past few years. It’s been a reaction to perceived domestic social threats to stability and external concerns about security. A side effect of China’s priority shifts is US and broader western disapproval of China’s direction. This has clearly accelerated as China became more assertive in foreign policy. In terms of polarization, it appears the US may not accept a compromise that the Chinese government is willing to make as sufficient to de-escalate.
With the above understanding, it is easy to see why China had chosen industrial capacity building as a way to both ensure self-sufficiency and to counteract western containment. This does nothing to alleviate deflationary pressure in China’s economy, which it is exporting (if marginally) to the world.
We see China’s economy needing two things to begin a more robust recovery, but neither seems to be on the cards.
Massive policy rate cuts toward zero (the level of policy rates in much of the developed world during the past two recessions): This would help remove any financing cost constraints to existing investment projects (such as mortgages and new infrastructure) and government policies (such as the local government property-buying scheme). The risk of such a policy is it could destabilize the currency and hurt bank margins, which authorities fear will destabilize the financial system. Ideally, this systemic risk can be mitigated with deposit insurance and government guarantees on banks. But Chinese authorities have little experience with deposit insurance and loathe to increase government guarantees on banks. They prefer to help by keeping a healthy profit margin for banks even as economic growth is constrained.
Substantial fiscal stimulus: In essence, a tangible recovery for China’s economy would be more likely if it followed past steps from developed governments like the US and EU with a policy of monetary-financed deficits, welfare spending and subsidies worth at least 2% of GDP. A policy of income support for new parents would cost dramatically less than government infrastructure spending. In our view, compensating businesses for hiring new college graduates would be helpful. Replenishing public elderly care and healthcare programs would likely support confidence, but the Chinese government appears to see technology and global competitiveness as more important economic objectives. The current emphasis on investing in infrastructure or high-tech industries is unlikely to produce a widespread, positive demand impact, and is hence ineffective so far.
