A silver lining for Chinese stocks

China’s Ministry of Commerce stated on its website today that the US and China “made new progress” at a vice-minister-level call. Chinese TV spoke of “hopes raised in recent weeks of a significant breakthrough” in the trade negotiations.

No more details are available to the public, but Chinese officials speaking on background expressed optimism that China would reach a working agreement with the Trump Administration before the tariff pause ends in March.

Both China and the United States have good reasons to want the talks to succeed. The Russell 2000 index of American small-cap companies has fallen by 16%, year-to-date, and 25% from its 2018 high, denoting a bear market. The ETF for large-cap Chinese H-shares, FXI, is down by 18% year to date, though it outperformed all major US indices during the fourth quarter.

The Trump Administration’s frequent references to the decline in China’s equity market as evidence that America was winning the trade war have come back to haunt it. The trade war triggered the stock market decline, in my view. I showed in a November 30 analysis that the global economic slowdown stemmed in large measures from a sharp drop in CapEx. Uncertainty about the status of global supply chains forces corporations to postpone investment decisions.

If the Trump Administration wants to get the stock market out of its present free fall, it will have to resolve the trade war issue. Other actions, for example, firing Federal Reserve Chairman Jerome Powell for failing to pump air into the bust stock market bubble are less convincing.

Trump appeared inclined to strike a deal with China at the Dec. 1 Buenos Aires summit meeting with Xi Jinping. Almost simultaneously, though, the US government launched a campaign against China’s flagship tech company Huawei, including the arrest of its CFO Meng Wanzhou in Vancouver. US officials remonstrated with other Western countries to boycott Huawei products as the Chinese telecom giant prepares a rollout of 5G mobile broadband.

From all indications the campaign to contain Huawei has been an embarrassment. For example:

Britain’s O2 mobile network will test Huawei 5G equipment, which suggests that Britain is not imposing a blanket ban.

Germany officially rejected American demands (the relevant entity is the Information Security Office in Bonn). On German television today, the chairman of Deutsche Telekom qualified American demands to exclude Huawei as “laughable,” saying, “Where are we supposed to buy the equipment?”

Central European governments have told the American government that Huawei is so deeply embedded in their telecom infrastructure that it cannot be extricated;

Huawei stated in China Daily Dec. 21 that it was still getting bids from Japanese customers.

Now the US has nowhere to go with its efforts to suppress Huawei’s influence. The campaign will grind down because there is nothing left to do.

The trade moderates in the administration (Treasury Secretary Mnuchin and top economic advisor Kudlow) have a much stronger argument to make on behalf of a deal. If Trump wants to get a vote of confidence from the stock market his most efficient course of action is to pursue a trade deal on the terms discussed in Buenos Aires.

Chinese stocks should be the biggest beneficiary of the turn we expect in US policy.