(Bloomberg) -- For all the trans-pacific nastiness between the world’s two largest economies, the possibility of outright trade war is so remote that Asian assets -- China in particular -- are a buy, according to UBS Global Wealth Management.
Stocks outside Japan could jump about 12 percent and Asian currencies may strengthen as much as 4 percent against the dollar should the U.S. and China negotiate a settlement, said Min Lan Tan, Singapore-based head of the UBS Asia-Pacific Investment Office.
“A negotiated settlement is our base-case scenario with 70 percent probability,” Tan said in an interview in New York.
In the latest sign that trade tensions are easing, Chinese President Xi Jinping this week renewed pledges to open industries from banking to auto manufacturing, drawing praise from U.S. President Donald Trump.
Here’s what else Tan had to say about trade, Asia assets and China:
Why negotiated settlement is most likely?
- Neither country has the appetite for open-ended trade war; China needs a long period of sustainable economic growth, accompanied by a slower pace of debt accumulation, to cut leverage and transition from old, manufacturing-led economy to new, service-oriented economy
- The U.S., after last year’s tax cuts, needs foreign capital to finance near-term deficit increases; Trump might keep his tariff threat, but only to gain an upper hand in talks and to extract concessions
- If China cuts tariffs and opens up its service sector, it will not only satisfy some U.S. demands but also raise China’s own productivity, thus creating a win-win situation
What if trade talks go nowhere?
- Even if the U.S. imposes 25% tariff on all imports from China (~$150b), Chinese growth in 2018 will only slow to 6.6% from current forecast of 6.9%
- China could retaliate in service trade, where the U.S. enjoys an advantage, as well as making it difficult for U.S. businesses to operate locally
- Selling or ending the purchase of U.S. Treasuries will mean mark-to-market losses for China and therefore be a low-probability choice
- There’s room for de-escalation and current standoff offers a good buying opportunity; markets can get used to and do get used to ongoing friction, such as the nuclear situation in North Korea
- Tan expects more clarity to emerge over the next two months; if tariffs are eventually imposed on less than $50b of goods, market will most likely rally
What do you recommend buying now?
- Tan favors equities and is overweight China, Indonesia and Thailand, while underweight Taiwan, Malaysia and Philippines
- Long China/short Taiwan equities as a hedge against trade-war escalation; Taiwan’s export-to-GDP ratio is far higher than mainland China, which also has greater capacity to offset any drag on exports from trade frictions
- Also likes short NZD/JPY as a trade-war hedge
What industries do you like in China?
- Tech: Chinese consumers are way ahead of peers in adopting new technology; also, government is expected to keep supporting big tech firms that help create new jobs and facilitate the re-balancing of China’s economic model
- Financials: positive trend seen in recovery of net interest margin, credit quality has also improved for big banks; banking sector trades at 0.8x P/B ratio, which is highly attractive
- Consumer discretionary: benefiting as growth drivers shift into consumption from investment
Do you worry about excess leverage in China?
- The issue with Chinese debt isn’t the amount but the pace of quick accumulation; that said, increases in China’s debt-to-GDP ratio already slowed down in 2017
- Growth remains key to solving China’s leverage problem; if China’s debt grows slower than the economy for the next 5 years, the debt/GDP number would look a lot less scary
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