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A Trade Deal ‘Born to Die’: China Outflows Highest in Four Years

Yakob Peterseil and Anchalee Worrachate

(Bloomberg) -- Traders have fled China-focused equity funds at the fastest pace in at least four years on the heels of renewed Sino-American tensions.

As Wall Street weighed the latest dramas between the world’s two largest economies last week, investors pulled $330 million from BlackRock Inc.’s iShares China Large-Cap fund, the most since 2016, data compiled by Bloomberg show.

All in, money managers divested $2.7 billion from Chinese stocks in the five days to May 13, the most since at least 2016, according to Goldman Sachs Group Inc. That brings the four-week total to $6.2 billion, outpacing emerging-market counterparts.

While pandemic-lashed investors are cheering any signs of a rebound in Asian investment and consumption, the geopolitical backdrop is darkening.

In the latest salvo, White House trade adviser Peter Navarro suggested that Beijing sent airline passengers to spread the infection worldwide. The missive follows reports last week that the White House planned to block Huawei Technologies Co. from global chip suppliers.

“Tensions with U.S. spurring equity outflow,” Goldman FX strategists including Zach Pandl wrote in a note. “At this point we have not built higher tariffs or other aggressive action (e.g. potential delisting of Chinese firms on U.S. exchanges) into our baseline forecasts.”

Overall market participants in recent weeks have focused squarely on positive data signaling how China is bouncing back from the pandemic. The country’s industrial output increased in April for the first time since the coronavirus outbreak, adding to early signs of a recovery that economists cautioned would be slow and challenging.

Global stocks have rallied more than 25% from March lows on soothing actions from central banks coupled with signs that the lockdown is easing across major economies. The question now is how much credence should investors give to the recent jawboning between the two powers.

Wild Cards

“It is one of the biggest wild cards in the 2020 outlook; the main uncertainty is whether the confrontation will be mainly rhetorical or evolve into concrete actions,” JPMorgan Chase & Co. strategists including Haibin Zhu wrote in a note. “But it is clear that the bilateral confrontation will expand beyond trade into other areas, including technology, finance, and geopolitical issues.”

At TD Securities, strategists led by Mark McCormick suggest a “rise in rhetoric” even without concrete actions would likely be enough to “spook markets” given the fragility of the economic backdrop.

Meanwhile at Nordea Bank ABP, Andreas Steno Larsen and Joachim Bernhardsen are telling clients to go long the dollar against Chinese currency risk as a high-conviction call, citing the breakdown in economic relations.

“The trade deal was always ‘born to die’,” the strategists wrote in a note. “But no one had an incentive to reveal it until after the U.S. election. The coronavirus has offered the Trump administration an opportunistic chance to opt for China bashing instead.”

Still, one widespread view maintains that President Donald Trump can scant afford to alienate his Asian counterparts given their mutual interest in combating both the virus and the global downturn -- clearing the path for cross-asset bulls.

“There is co-dependency there which reduces a chance of a big fallout at this stage,” said Seema Shah, chief strategist at Principal Global Investors.

All the same, Wall Street strategists recommend cross-asset hedges while they’re cheap.

At Susquehanna, Chris Murphy points out that the 30-day implied volatility for the BlackRock ETF, ticker FXI, has been trading largely in line with its American counterpart, the SPDR S&P 500 Trust. Yet the market calm looks potentially unsustainable -- a backdrop that has previously rewarded options traders using the popular ETF to hedge trade-war risk.

“Given China’s dependence on trade as nations look to rebuild supply chains from within, combined with risk of increased tensions with the U.S. and a potential for reinstatement of tariffs, I think volatility is too low (especially compared to SPY),” the derivatives strategist wrote in a recent note.

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