ISQ – July 2023
Ed Mills, Managing Director, Washington Policy Analyst, Equity Research
We are of the view that a trend of reindustrialisation and de-risking will be a market theme that investors will navigate in the years ahead.
Recent policy decisions are the foundation for an industrial renaissance aimed at building up the US economic base and protecting it against some of the geopolitical and supply chain risks that have had significant impacts in recent years.
Concern over China’s longer-term geopolitical ambitions and the threat posed by China’s military to the US and key allies has been a major focus of US policy in recent years, leading to that policy viewing technology as a national security asset.
The US government has enacted policies with both ‘sticks’ and ‘carrots’ that create challenges and opportunities for investors navigating the shifting global environment.
We expect material market impacts over the coming years as this economic transition takes shape.
Are the US and Chinese economies decoupling, or are we seeing a more strategic approach to national security priorities and supply chain resiliency? The answer to this question depends upon the policy decisions over the next several years and could have massive implications for the global economy and equity market. We are of the view that a broad-scale decoupling and the formation of regional economic blocs is less likely, but a trend of reindustrialisation and de-risking will be a market theme that investors will navigate in the years ahead. We also argue that recent US policy decisions are the foundation for an industrial renaissance aimed at building up the economic base of the country and protecting it against some of the geopolitical and supply chain risks that have had significant impacts in recent years—most acutely felt during the COVID supply chain shortages of critical materials. Key aspects of this industrial renaissance are a series of ‘carrots’ in the form of tax subsidies and direct support vs. the initial phase of ‘sticks’ in the form of tariffs, blacklistings, and tech restrictions.
A trend of reindustrialisation and de-risking will be a market theme that investors will navigate in the years ahead.
US and China at a crossroads: A shift in the global economic order
Concern over China’s longer-term geopolitical ambitions and the threat posed by that country’s military to the US and key allies has been a major focus of US policy in recent years. During the Trump Administration, concerns about China’s unequal market access and intellectual property theft led to a 2018 ‘trade war’ with tariffs levied against a broad set of China’s imports into the United States. A key concern was that US technology that was traditionally used for civil use could be repurposed and used to further military ambitions. This led to US policy viewing technology as a national security asset, leading to new export restrictions and blacklisting various Chinese companies from receiving access to US technology, especially in the semiconductor space. The flow of US capital into critical sectors in China that finance the country’s economic competition with the US also came under enhanced scrutiny. While this economic confrontation was initially driven by national security considerations, the COVID-19 pandemic exposed additional vulnerabilities around global supply chains, particularly with technology components and medical goods that drove shortages and spiked prices. These conditions set the stage for a rethinking of US-China economic relations that quickly became a bipartisan consensus in Washington.
Government Response: Securing supply chains & investing in the domestic industrial base
In response to the dynamics outlined above, the US government has enacted policies with both ‘sticks’ and ‘carrots’ that create challenges and opportunities for investors navigating the shifting global environment. Export controls, tariffs, and economic restrictions through the blacklisting of certain companies have created revenue and cost challenges for US companies with significant exposure to China’s market. Frequently, these policies are announced with little warning and carry high impact—raising headline risk for exposed sectors. However, policymakers have also unleashed more than $1 trillion in domestic investment across pandemic relief measures and new funding for domestic infrastructure, semiconductor manufacturing, and the energy transition. Key legislation on this front includes the 2021 American Rescue Plan ($350 billion in funding for infrastructure), the 2021 Infrastructure, Investment, and Jobs Act ($550 billion), the 2022 CHIPS and Science Act ($52.7 billion), and the 2022 Inflation Reduction Act ($392 billion). These new policies direct federal funds and catalyse private sector investment toward what we refer to as the ‘reindustrialisation’ of North America. In combination, the goal of these policies is to fortify the US domestic industrial base and limit future economic dependencies that can drive economic disruptions or be used against the US as economic leverage. Even with this level of new investment, we still see significant appetite in Washington to build on and supercharge certain aspects of the domestic economic agenda. Permitting reforms, investments in critical minerals, and preserving a role for legacy energy to limit transition risks all contribute to economic growth prospects over the years ahead. The global impacts of the war in Ukraine add a national security imperative around these goals. Vulnerabilities experienced by countries with oil and gas dependencies following Russia’s invasion of Ukraine have prioritised projects that build out legacy energy infrastructure and limit potential vulnerabilities around critical minerals as the energy transition gains pace. In this sense, policymakers are wary of replacing dependence in the oil and gas space for critical mineral dependencies with supply chains heavily concentrated in China. Overall, the events of the last several years have placed national security and economic disruption concerns as leading drivers of policymaking in Washington.
Permitting reforms, investments in critical minerals, and preserving a role for legacy energy to limit transition risks all contribute to economic growth prospects over the years ahead.
As markets digest the impact of this trend, we see clear winners and losers from an investment perspective. As federal funding is deployed and the reindustrialisation theme plays out, we expect Industrials to be a clear beneficiary. New investment and market opportunities for the energy transition will be a material boost for clean energy equities. We see the transition as balanced across the energy space with permitting reform boosting the buildout of energy infrastructure and increasing demand for liquified natural gas (LNG). In terms of potential headwinds, the Technology sector will be a space that is exposed to risks as the policy impact unfolds. Emerging technologies such as artificial intelligence (AI), quantum computing, and robotics will be in the crosshairs of new controls and regulations which can limit the ability of certain companies to scale and penetrate China’s market. Biotechnology and pharmaceuticals are other areas to watch which could see similar controls in the future. In all, we expect material market impacts over the coming years as this economic transition takes shape.
” Overall, the events of the last several years have placed national security and economic disruption concerns as leading drivers of policymaking in Washington. “
Investors should be aware of critical trends that will impact the evolution of this emerging theme. First, China’s response can increase market risks if US policy actions are seen less as ‘de-risking’ and more as ‘decoupling’ by another name. US companies could be targeted as retaliatory steps, which could raise overall US-China tensions. The fate of Taiwan and the outcome of its presidential elections in January 2024 will also be important to monitor. While the Biden administration is taking steps to de-escalate tensions around the question of Taiwan’s status, China perceiving Taiwan as moving closer to independence could accelerate the timeline for a regional conflict that could drive global economic disruption on a significant scale. Lastly, the inflationary impact of a shifting global economic order will have important consequences for the direction of monetary policy. Higher costs and elevated spending could weaken the Federal Reserve’s tools to fight inflation and prolong high interest rates—a ‘higher for longer’ scenario. We expect attention to increase on these issues over the next year, especially as the US prepares for the 2024 presidential election campaign that will help determine the trajectory of a changing macro investment environment.
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