January 7, 2019

In a world economy producing $80 trillion per year, according to World Bank estimates, the U.S. portion is set to top $22 trillion (27% of the total) in 2020. That’s a huge chunk of the world’s total gross output, and it pretty much explains the assumption, “as the U.S. economy goes, so goes the rest of the world.”

Top Ten Biggest Economies Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Over the past two years, China’s economic momentum has slowed, due to trade war. While the U.S. economy stands to risk slipping below 2% GDP growth in 2021 and 2022, a lot can happen between now and then. For instance, a crucial and way overdue U.S. spending bill on infrastructure of around $1 trillion could goose future GDP figures higher for the next two years, if and when that legislation comes to pass.

United States Economic Outlook Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This past week, State Street Global Advisors forecast China’s 2020 GDP falling below 6% (to 5.7%-5.8%) for the first time since 1990 as the current tariffs in place and cooling infrastructure spending reduce growth. The Phase One deal with China is set to be signed on January 15. Although the deal represents little progress in the key areas of U.S. interests, namely accountability for cyber espionage and forced technology transfer, the markets warmed to this breaking of the months-long political gridlock.

It is understood by both sides that Phase Two will focus more on these matters and not just be a deal for China to buy more farm products, energy and manufactured goods from the U.S. in order to reduce some tariffs on Chinese imports. While both sides state that they will address some disputes over intellectual property, this area has no terms set forth and thus remains just a talking point.

To rehearse the highlights of the Phase One deal, the U.S. suspended planned 15% tariffs scheduled to go into effect on December 15 on nearly $160 billion worth of Chinese goods, including cell phones, laptop computers, toys and clothing. China canceled its retaliatory tariffs (due to take effect that same day), including a 25% tariff on U.S.-made autos. The U.S. Trade Representative’s office said it would cut by half (from 15% to 7.5%) the tariff rate it imposed on September 1 on $120 billion of Chinese goods. The U.S. tariffs of 25% on $250 billion worth of Chinese goods will remain unchanged, providing the U.S. with some powerful negotiating leverage for a second phase of negotiations later on, according to USTR.

China has agreed to increase purchases of American products and services by $200 million over the next two years, boosting exports to China by almost 100%. On the surface, the deal looks constructive, but neither side has released any details of the agreement yet. Chinese officials describe the deal in guarded terms, not publicly confirming Washington’s version, especially on goods purchase commitments.

China Gross Domestic Product Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Big Potholes in China’s 2020 Structural Road

China’s domestic economy is under pressure from several fronts. One major drag on growth is that lower investment in the sluggish housing market is putting downward pressure on the economy, and that slow decline will fester in 2020 as the government maintains tight controls over property speculation and restricts property developers’ ability to raise capital for speculative building.

Infrastructure spending, a key tenet in China’s torrid growth from 1990 through 2012 has also slowed, forcing local governments to speed up the issuance of special purpose bonds that targeted public works projects in 2019. Infrastructure spending for the first 10 months of 2019 rose only 4.2%.

Meanwhile, producers and supply chains are moving out of China. Tariffs and ongoing uncertainty are driving companies to relocate production to neighboring countries like Taiwan, India, Vietnam, Malaysia, the Philippines and Indonesia. According to The Wall Street Journal, Apple is considering moving 15% to 30% of its manufacturing to India, and Dell may move its personal computer production to Taiwan.

As Shawn Nelson, CEO of Stamford, CT furniture maker The Lovesac Company, stated: “once you move, you don’t go back.” His company has cut its production in China from 75% at the beginning of 2019 to where the company will have no production in China by the end of 2020. Cummins is also moving operations of its diesel engine production to India and other countries.

Navellier & Associates does not own Lovesac, Cummins, or Dell, but does own some Apple in managed accounts. Bryan Perry does not own Lovesac, Cummins, Dell, or Apple in personal accounts.

According to the November 29 Caixain report (“China’s Economy Set for More Pain in 2020 as growth Forecasts Sink Further”), these and similar moves by U.S. companies add up to a reordering of global manufacturing supply chains as they prepare for an extended period of uneven trade relations.

Companies said these shifts accelerated after the tariff on many Chinese imports rose to 25% from 10% in May. Executives at companies that are moving operations outside China said they expect to keep them outside China because of the time and money invested in setting up new facilities and shipping deals.

President Xi and China’s senior Communist party officials love to be masters of the long-range game, exercising patience and waiting out any troublesome presidents and their administrations, but the Chinese economy has some serious structural problems. To top it off, China’s total debt — corporate, household and government — rose to over 300% of its GDP in the first quarter of 2019, slightly up from the same period a year earlier, according to a report by the Institute of International Finance.

If Phase Two deal negotiations go beyond the 2020 election, a re-elected and emboldened President Trump may not go easy on China. It’s my take that President Trump will look at the first quarter data from China, which is surely to have deteriorated from Q1 2019, and wait until 2021 to pursue Phase Two and really tighten the screws on China’s egregious behavior in many areas. At that point, just maybe, the business of China trying to “save face” won’t amount to a hill of soybeans.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry