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Three political risks to investing in 2020

As we enter the new year, we consider how political issues could continue impacting the investment space. In our view, there may be three key political risks to markets in 2020.

1. Unsurprisingly, the first and most widely discussed risk is the US–China trade relationship

In short, the real question is: which country will be the pre-eminent power in the 21st century? We believe the trade war can be interpreted as just one component of a much deeper, longer-term geopolitical rivalry between the two countries. In this context, the trade war may also be linked to political issues surrounding Taiwan, the protests in Hong Kong and China’s territorial claims in the South China Sea. While December’s phase-one trade announcement does not resolve the underlying tensions between the US and China, it does represent movement forward after months of uncertainty. It also seems to be in both parties’ best interests – for now. From President Trump’s perspective, he needs a strong US economy as the presidential election approaches. A further escalation in the trade war is therefore not an optimal path for him – at least, not until he wins a second term. President Xi also needs a deal, given the weakening Chinese economy and his loss of prestige due to unrest in Hong Kong.

 

At the time of writing, a phase-one trade deal, which spans some ninety pages, was signed on 15 January. In essence, China has committed to the purchase of an additional US$200 billion of US exports over two years in exchange for a limited rollback of US tariffs. However, there are still some questions surrounding how China will afford additional purchases as well as the potential implications of the enforcement mechanism, which could allow “each party to take proportionate responsive actions that it deems appropriate” if any potential issues fail to be resolved under the agreement’s Bilateral Evaluation and Dispute Resolution Arrangement. What is also unclear is what issues may be tackled if and when the nations enter phase-two talks.

 

We believe the announcement of the phase-one deal has removed a large degree of uncertainty from the global economy and that the risk of further escalation in US–China trade tensions has been reduced significantly – at least until the US presidential election in November. This is a clear positive for both the global economy and risky asset classes. However, the longer-term structural tensions between the US and China remain intact. The US’s demands on intellectual property and market access pose an existential threat to the current Chinese political economic system, while the passing of the Hong Kong Democracy & Freedom Act by the US Congress is believed to have added to tensions and complicated negotiations. Therefore, we believe any agreement may only be temporary in nature and no more than a bilateral promise to restrain from further escalation.
 

2. A much less discussed political risk is the 2020 US presidential election

Financial markets are unlikely to pay much attention to the election until mid-2020, when the identity of the Democratic nominee will become clear. Given the Democrats have become increasingly ideological, populist and anti-corporate since Trump’s election, it is possible that a left-wing populist, such as Senator Elizabeth Warren or Senator Bernie Sanders, will be the nominee. It is our view that the prospect of a populist left-wing US president will not be welcomed by financial markets. Senator Warren may be as protectionist as Trump, though for different ideological reasons, and favour higher tax and more interventions in the market – in particular, stronger bank regulations.


Finally, it would be remiss for us not to comment on the impeachment of President Trump by the US House of Representatives. As at the beginning of January, the next step in the process is a trial in the US Senate. While the trial will generate a lot of publicity and political fireworks, its immediate impact on financial markets will likely be limited given that a 2/3 majority in the Senate is needed to remove a president from office. With the Republicans’ 53 seats in the Senate, it is almost impossible to envisage 22 Republican senators voting for removal. However, the trial is likely to polarise the US further and set the scene for what we anticipate will be a bitter and divisive election.
 

3. The third identifiable geopolitical risk is the fallout from Brexit

The Conservative Party’s majority win in last year’s UK election can be interpreted as an endorsement of the latest agreement, which leaves Northern Ireland in the EU Customs Union. Regardless of Brexit developments, Prime Minister Johnson will need to navigate new relationships with Europe and, given half of the country’s exports are to the region, will also need to work to soften the blow the economy will likely experience after it eventually leaves the European Union. Signing an agreement before the end of 2020 may be too short a time for the prime minister to finalise arrangements between the regions, potentially leading us into 2021. In the meantime, Europe could also face its own trade challenges with both the US and China, which means the region could continue facing volatility over the coming year.

The other hot topics to consider

While the above are the main geopolitical risks to monitor in 2020, there are a number of other well-known risks that may impact financial markets over the coming year. We include in this list the situation in Iraq and Syria, the US–Iran standoff on nuclear weapon development, North Korea and China’s policies in the South China Sea, as well as ongoing developments in Hong Kong and Taiwan, where a pro-independence president will likely be re-elected in early January.


Finally, there is always the “unknown unknown” which has a tendency to catch investors by surprise! One example of such events is that no observer forecasted that Hong Kong, Asia’s global financial centre with a reputation for political apathy, would be plagued by mass protests in 2019 – pushing the US–China relationship to the brink of a very nasty disengagement.


As these events continue to unfold, the Colonial First State Investments team will continue its proactive approach to investing by working closely with skilled investment managers to monitor change and identify risks and opportunities in markets on behalf of our members.
 

Written by George Lin, Senior Investment Manager, Colonial First State

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