United Kingdom, Intermediaries

US-China decoupling tops my list of investable themes

When it comes to the US and China “decoupling” from one another, Macro Strategist Santiago Millan thinks investors should be more attuned to what to buy than what to sell.

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It’s no secret that the US and China have been “decoupling” from one another, in keeping with the broader deglobalization theme that has been underway for some time now. The decoupling is occurring across a variety of vectors — goods and services, people, ideas, technology — and should only continue to gain traction going forward.

Supply-chain migration

One of the most talked-about forms of US-China decoupling is that of supply-chain migration. China’s role in global supply chains is gradually becoming less prominent, particularly vis-à-vis the US as China’s overall US footprint shrinks (Figure 1). To some degree, this type of decoupling is forced, or at least facilitated, by protectionist policies on the part of both nations (e.g., increased spending and subsidies for critical domestic industries).

FIGURE 1

China's US footprint is disappearing faster than it appeared...

If China is the source of global supply-chain migration, Southeast Asia is a primary destination. Some of the manufacturing activity that once took place predominately in China is shifting to countries like Vietnam and Thailand, which have lower wages and do not face tariffs from the US. That’s one reason China’s share of world exports peaked in 2015. Recently, US-China tensions and COVID-19 have accelerated the process by providing a justification for reshoring production of strategic goods like semiconductors and medical supplies.

Interestingly, while the US and China decouple, one underappreciated trend is that China is actually becoming more integrated with most of Asia and much of Europe as well, particularly Germany.

Looking beyond the COVID-19 crisis, there should be enough supply-chain migration to keep many countries engaged for years or perhaps decades to come. By way of illustration, Vietnam’s total manufacturing output is around 1% of China’s. This means that if 1% of Chinese production migrates to Vietnam, the latter’s output will double.

Meanwhile, China’s massive size and scale will be the backbone of strong ongoing demand for manufactured goods from elsewhere in Asia. This should help ensure the continued presence and emergence of many clusters of global supply over time.

Risks and opportunities

Clearly, supply-chain migration (and US-China decoupling in general) creates global inefficiencies and risks, both geopolitical and economic. Countries, industries, and individual companies worldwide are likely to be affected. Some impacts are obvious, but others less so. For instance, even the supply chains of global financial firms may be increasingly disrupted.

On the flip side, the resulting distortions should also create longer-term opportunities for discerning investors to pursue alpha. As one example, some of the protectionist policies helping to drive supply-chain migration may give rise to investable national “winners” in both China and the US. This is because there will be generous spending by both Asian and Western governments on investing in areas where they wish to remain competitive. Investors should consider aligning their portfolios with companies that look poised to benefit.

Bottom line

When it comes to US-China decoupling, I think shrewd investors should be more attuned to what to buy than what to sell. The possibilities are numerous, in my view, and likely to come into sharper focus as time goes by.

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