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U.S.-China Trade Talks Keep Getting More Complicated. That’s Not Good for Investors. - Barron's

Photograph by Ng Han Guan/AFP/Getty Images

The U.S. opened new fronts in its conflict with China in recent days, complicating this week’s trade negotiations and leaving companies with little hope that the uncertainty they’ve been facing will clear up soon.

The developments—including an expanded list of blacklisted Chinese firms, a potential implementation of capital-flow controls, as well as the firestorm over a Houston Rockets executive’s tweet supporting of pro-democracy protesters in Hong Kong—could make for an uncomfortable meeting when the two sides meet on Thursday. Money managers and strategists have tempered expectations and fear that even progress toward a mini-deal will not bring much clarity to the ongoing tit-for-tat trade dispute.

While President Trump this week said he was still looking for a “comprehensive deal,” reports say the Chinese are looking for a mini-deal and are taking some major issues related to their industrial policy off the table. What’s clear is that both sides have incentive to reach some sort of a truce.

“Tariffs have taken their toll. European and Japanese exports to China are up 20% and the U.S. is down 20%. We are losing market share rapidly and losing the impact of 40 years of hard work rapidly,” says Craig Allen, president of the U.S.-China Business Council, which represents 200 American companies doing business in China. “Both want a deal and a narrow deal is absolutely out there, but will require some political will on both sides. If [a light agreement] is perceived to be first of a number of agreements or down payment on a resolution of issues, that would be positive.”

Such a deal could build on China’s agreement to buy agricultural products and offer some intellectual-property protections and market access. Those are two areas where it is increasingly in China’s interest to strike a deal so as its companies become more innovative and the country tries to woo foreign investment into areas like financial services.

Investors though aren’t putting much stock in political will. The iShares MSCI China ETF (ticker: MCHI) fell 1% at $55.71 in late-morning trade while the major U.S. stock indexes tumbled amid concerns about this week’s trade talks.

If the tariffs set to go into effect Dec. 15 are delayed and the two sides strike a “micro deal,” Mark Haefele, UBS Global Wealth Management’s chief investment officer, says it could be a short-term positive for stocks. However, he doesn’t expect any small agreement to clear the uncertainty weighing on business sentiment and the broader global economy.

A trio of developments in recent days, however, could complicate efforts to strike a trade deal of any sort.

• The Commerce Department late Monday blacklisted 28 Chinese entities, including video-surveillance and facial-recognition companies Hangzhou Hikvision Digital Technology and SenseTime Group, citing their role in China’s repression of Muslim minorities in northwest China. The move prohibits U.S. suppliers from providing technology to these companies without a license—similar to what the U.S. did with Huawei Technologies earlier this year.

The move won’t have much impact on the Chinese companies since they also have foreign suppliers, making it largely a symbolic gesture—and one that raises China’s ire over what it sees as the U.S. meddling in its sovereign affairs. China said to stay tuned for retaliation.

• The possibility the U.S. takes steps to restrict capital flows to China bubbled up again after a Bloomberg report Tuesday. The report said the White House was considering such measures with a special focus on U.S. government pension investments and index providers’ decisions to include Chinese companies the administration considers a material risk for investors.

The latest report follows denials from the White House late last month that the administration was considering similar proposals, including a bill introduced by Sen. Marco Rubio (R., Fla.) and others to delist Chinese companies that don’t open their books to a U.S. audit.

• The U.S.-China conflict also spilled into the mainstream after a tweet by Houston Rockets general manager Daryl Morey in support of pro-democracy protesters in Hong Kong, leading China to cancel broadcasts of preseason games, merchants to stop selling NBA merchandise, and jeopardizing the NBA’s brand in a country that is a source of major growth. The situation offered a glimpse at the wide reach of the conflict and the tricky situation global companies—and investors—increasingly find themselves in.

With both sides’ broader interests still far apart, Rajiv Jain, chief investment officer at GQG Partners, which oversees $26.5 billion in assets, says he would look at any rally on a mini-deal as an opportunity to sell. “Longer term, no one has yet factored in that China may be buying a lot less in three years from the Apples and chip companies of the world if China slowly decouples from the West—because China will become more self-sufficient in terms of semiconductor manufacturing, which is already happening at the lower-end,” Jain says.

The situation could also lead to more pain for markets if the recent discussions about restricting capital flows into Chinese assets gain traction. For some context, China makes up just 3% of the MSCI World index, with U.S. investors not heavily invested in the country. But even the mildest form of restrictions would create wide ramifications that the market hasn’t priced in, says Christopher Smart, chief global strategist at Barings.

“It is a very important line to cross because it essentially is signaling it is bad form to own these companies,” Smart says. “It creates a whole new investor risk calibration over and above tariffs on soybeans and technology.“

Such a move would likely hit the American depositary receipts of Chinese companies, including the likes of Alibaba (BABA) and education stocks like New Oriental Education & Technology (EDU).

But longer term it would also hurt U.S. investors, keeping them from participating in the “biggest economic miracle there has been,” says Jan Dehn, head of research at Ashmore Group. “China is playing the long game and will continue to liberalize their markets. If the U.S. doesn’t want to participate and creep into a hole and hide, it won’t prevent China from opening its markets and growing its influence globally.”

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It is unclear what the next move may be but recent developments appear likely to harden attitudes on both sides. “China will continue to try to self-develop links in what used to be global supply chains and U.S. companies [will continue] to develop non-China supply chains,” says Howard Wang, Head of Greater China Equities, J.P. Morgan Asset Management.

“From a short-term standpoint, a narrow deal probably doesn’t resolve the root causes and lack of trust underlying U.S.-China tensions, so I would expect companies continue to stay circumspect on capex decisions,” Wang adds. He has been adding to non-trade-sensitive technology stocks and some parts of financial services seeing strong growth while paring back holdings in consumer stocks that have done well to date.

The overwhelming consensus: The U.S.-China conflict isn’t a risk investors are going to be able to brush away soon.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

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