The Art of War by Sun Tzu

Part II

By Barry Lau, Managing Partner & CIO (Private Investments)
November 2018​

“Do Not Engage an Enemy More Powerful than You

and if it is Unavoidable and You do have to Engage,

Make Sure Engage it on Your Terms, Not on Your Enemy’s Term”

 

China’s 2025 well publicized ambitions may have raised a few eyebrows, in particular, in Washington. Whilst the U.S. has the economic, political and military might well in excess to that of China and has consistently taken a hardball approach to the trade talks, recently, it may be observed that President Trump has softened his stance as illustrated in a recent tweet: “Just had a long and very good conversation with President Xi Jinping of China. We talked about many subjects, with a heavy emphasis on Trade...” Trump added that he planned to meet Xi in late November on the sidelines of a G20 summit in Argentina.

On 6 November 2018, Wang Qishan, China’s Vice President, made a speech at the New Economy Forum in Singapore, held by Bloomberg addressing the major challenges facing the world including China:

It is our firm belief that China and the U.S. will both gain from cooperation and lose from confrontation. China will embrace greater openness and work for mutual benefit. Both China and the US would love to see greater trade and economic cooperation. The Chinese side is ready to have discussions with the US on issues of mutual concern and work for a solution on trade acceptable to both sides.

Much like the importance for Trump during the Mid Term Election, coming up is China’s Fourth Plenary Session of the Party’s 19th Congress, which will largely establish President Xi’s policy on economic and financial matters during the remainder of his term. China has delayed the Fourth Plenary Session several times, we believe that the intention is to play a diplomatic game that will help ease tensions.

The U.S. is aware of these maneuverings, and Secretary of State Mike Pompeo reportedly said after a meeting in Washington with Yang Jiechi, the former Chinese ambassador to the U.S., “The U.S. is not pursuing a Cold War or containment policy with China... Rather, we want to ensure that China acts responsibly and fairly in support of the security and prosperity of each of our two countries.” Yang commented: “The Chinese side is committed to peace and development in the Asia-Pacific…we will definitely not seek hegemony, however strong we may grow.” The key individuals on both sides are now rushing to pave the way for the two leaders to strike a deal before they meet at the end of this month. Sun Tzu would have explained:

“Make your enemy think that your normal force is extraordinary and your extraordinary is your normal.”

On a balance of probability, our base case assessment for a favorable outcome relating to the trade talk has become more positive as a result of the below developments:

1.      Imports from China to the U.S. have actually increased since the trade talks commenced. There are many reasons for this, but two key drivers are as follows: a) whilst order books for any given year is usually well planned, the threat of a trade war could spook buyers to secure supplies earlier than the usual purchasing cycle; b) China has been the factory of the world for the last three decades, building up technical expertise (not always obvious to a layman’s naked eye) and becoming an integrated part of global supply chains. Hence, China cannot be so readily and easily replaced by another country.

2.      President Trump has been advertising the performance of U.S. equities as his most important achievement during his presidency thus far. He will need to focus on making some meaningful progress towards reaching a trade agreement to ensure his claim over the equity market performance can be sustained.

3.      The co-dependence correlation between the U.S. and China has never been greater as China has embarked on diversifying its trading partners along the Belt and Road Initiatives. The same dollar amount of trades that has historically been earmarked for the U.S. may now be spread across different trading partners. The result is less economic benefits for the U.S. and should provide an impetus to pursue a favorable outcome at the much anticipated meeting on 27 November.

We believe that if the trade talks do progress favorably then emerging markets, and in particular, China’s stock market, should outperform the rest of the world. Given how fund flows have drained these markets, especially China, in the last two months, we believe a positive outcome will send cash back into these very fragile markets.

However, notwithstanding all efforts from both sides, everything could end at a moment’s notice subject to President Trump’s state of mind which has been known to be fascinatingly agile.  From another chapter of Sun Tzu, with which perhaps President Trump is already well versed:

“Engage people with what they expect; it is what they are able to discern and confirms their projections. It settles them into predictable patterns of response, occupying their minds while you wait for the extraordinary unanticipated moment to attack.”

Finally, we close by a final remark from Sun Tzu:

“In the midst of chaos there is also opportunity.”

There is no need to be too pessimistic! Have a great week ahead.

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