Supply Chain Realignment to Reshape Global Investment Landscape

The deteriorating relationship between China and the United States will have profound impacts on the global markets. Nationalism was already on the rise on both sides of the Pacific when the COVID-19 crisis exposed vulnerabilities to the global supply chain. As global trade reorients, certain countries will prove to be better aligned to capture relocating U.S. manufacturing. Investors should watch closely for the forerunning signals of which countries will benefit.

The global economic shock of COVID-19 has prompted commensurate fiscal and monetary responses from governments and central banks. For investors in global securities markets, recovery in growth and employment are the key variables to watch.

In the near term, growth will face the headwinds of continued shutdown risks and increased consumer savings (thus depressed consumer spending).

Over the long term, a robust recovery will be challenged by a sea change in supply and demand factors. National security concerns in the U.S. will drive production back to America and introduce it in other Western Hemisphere countries. Consumer behavior will shift as new technologies continue to disrupt old business models and practices. And the burden of increased debt will dampen future consumption. It is too early to say how these issues will play out, but investors should pay attention for signs of the winners and losers in the post-COVID recovery.

Chinese infrastructure investment is expected to pick up substantially this year. The focus of this investment will target both the old economy of transportation, pipelines and upgrades to residential buildings as well as new-economy projects. The latter, which are likely to be more durable in my opinion, include 5G applications, next-generation information networks and electric-vehicle infrastructure.

The formation of a new geopolitical landscape, however, will counterbalance the drivers of growth in Asia. Under its newly re-elected president, Taiwan has embarked on a more hawkish stance to mainland China. In response, Beijing will likely increase pressure on Taiwan’s economy. It will be important to see how Taiwan develops supply chains with the Western world.

Hong Kong faces a long-term decline in its standing as a hub of international trade and finance. On May 28, China’s National People’s Congress approved a draft proposal — by a vote of 2,878 to one — for new national security legislation in Hong Kong. U.S. Secretary of State Mike Pompeo had announced May 27 that “Hong Kong does not continue to warrant treatment under United States laws in the same manner as U.S. laws were applied to Hong Kong before July 1997.”

It is now up to the U.S. Congress via legislation, or President Trump via executive order, to adjust the Hong Kong Policy Act, which provides special status to the special administrative region. The special status exempts Hong Kong from some of the tariffs applied to China and has been a factor in Hong Kong becoming a trade and finance hub in the region. But the U.S. needs to be careful, as its actions could not only hurt Hong Kong but benefit Beijing. By treating Hong Kong the same as the rest of China, Washington could solidify the mainland’s grip on Hong Kong, an outcome fundamentally at odds with American support for the island’s pro-democracy movement.

Over the medium term, Hong Kong appears likely to lose its status as China’s premier trade and finance hub to the benefit of Shanghai and other regional players such as Singapore, Japan, South Korea and Vietnam. In fact, the U.S. is building an Economic Prosperity Network that might include these four nations.

In the Western Hemisphere, candidates for re-onshoring will consist of critical technologies and healthcare products but might also include the producers of more basic items for which society has increased demand during the pandemic such as food and everyday household items.

According to the nonpartisan U.S. Congressional Research Service, “Because of China’s role as a global supplier of PPE [personal protective equipment], medical devices, antibiotics, and active pharmaceutical ingredients (API), reduced exports from China have led to shortages of critical medical supplies in the United States.”

On the technology side, the U.S. Department of Commerce on May 22 designated new Chinese companies as risks to national security. This will restrict their access to sensitive U.S. technology. These actions are disrupting and changing global supply chains. Technology is very important, as China is the U.S.’s largest supplier of goods, including electrical machinery, such as computers and telecommunication equipment, which is the largest category of imported goods.

The policies will need to be watched closely to see how quickly large economies such as those of the United States and the United Kingdom adjust their supply chains. To address concerns expressed by his Conservative Party about China, Prime Minister Boris Johnson is targeting zero involvement for Chinese tech giant Huawei in the U.K.’s 5G networks by 2023.

Rather than moving all their production capacity from China to within their own borders, the U.S., U.K. and Europe might seek to diversify their supply chains into other countries with which they have close geopolitical ties as well as within their own borders. Two major semiconductor manufacturers, Intel and Taiwanese Semiconductor Manufacturing Co., are seeking to build semiconductor production facilities in the U.S. We should be on watch for moves to bring inputs to various industrial sectors back onshore – especially in pharmaceuticals, aerospace, autos and technology. It is likely that these supply chain adjustments by the U.S. would benefit countries like Mexico and Canada.

To be sure, other issues than China will reshape the investment landscape, such as the rise of debt; widening of deficits and corresponding increases in taxes; increased government ownership of markets; changing demographics, consumer preferences and savings behaviors; and accelerated use of new technologies. But I do believe that there is no going back to the old globalization model. New models, centered on nation states and allied nation states, will arise post-COVID-19.