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China: On Tariffs and Consequences

President Trump recently announced tariffs on certain Chinese goods, and China responded with tariffs of their own. As we write, the situation appears to be escalating, and the possibility of a trade war has markets concerned, including non-US markets and especially emerging markets, led by China. The Shanghai Shenzhen CSI 300 Index fell nearly 10% in US dollar terms in the last two weeks of June. While fears of a potential global slowdown seem to have hurt most markets, in this commentary we will focus on China, where TIFF’s comprehensive portfolios have a meaningful overweight exposure vs. the MSCI All Country World Index (ACWI).

To cut to the chase, we intend to make no major portfolio changes in response to these tariff developments. We will explain why but let us start by reiterating the positive backdrop that we believe supports our position. First, China is the second-largest economy in the world and has the second-largest domestic stock market. It currently represents an approximately 4% weight in the ACWI and will likely become a mid-teens weight at some point under MSCI’s gradual inclusion of China “A shares,” i.e., those traded on mainland domestic exchanges. Second, approximately 75% of the trading volume on China’s domestic exchanges arises from local retail investors. The US, which represents 54% of ACWI trading volume, is dominated by institutional investors. The lack of sophisticated market competitors in China suggests that the China-focused managers in our comprehensive portfolios should generate higher alpha than an equally talented manager focusing on the US. Finally, today Chinese stocks trade at price/earnings multiples of about 11x forward estimated earnings vs. US stocks at 17x. This strikes us as an unusually advantageous starting point.

This is an excerpt from a longer article. Please download the PDF to read more.

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