Potential Impact of China Developments

By Edgar Sullivan, CFA and Anja Needham, CFA

May 2022

The differences between the China-Taiwan situation and the Russia-Ukraine situation far outweigh the similarities. In this paper, we explore the impact and exposure to these geopolitical risks.

China is committed to reunification with Taiwan, but it is also committed to its common prosperity and growth objectives – e.g., 5.5% this year. The leaders of China feel that time is on their side and precipitous action is not required. For example, in 2019. Xi linked reunification with Taiwan with his overarching goal of achieving China’s “national rejuvenation” as a world power by 2049, the centenary of the People’s Republic of China.

China may cooperate with Russia in areas of common interest and welcome gaining preferential access to Russia’s natural resources. However, we believe that China’s support is likely to be measured — particularly as we witness the seeming success that Ukraine is achieving in repelling Russia’s aggression, the responses of Western Europe and the US, and the devastating effects that the sanctions appear to be having on Russia’s economy. China is unlikely to explicitly declare support for Russia’s invasion of Ukraine, and unless they do, the risk of direct sanctions on China or on Chinese entities appear limited.

However, there is a risk of sanction spill-over, relating to the activities of Russian entities in China. Given the complex and evolving links between trade and investments, assessing the potential impact is not entirely straightforward – but is something our managers are closely monitoring. Additionally, Russia’s invasion of Ukraine has set off a chain of events including surging commodity prices, sanctions, and new trade bottlenecks that are requiring economists to revisit their global outlooks. For example, the OECD has recently reduced their outlook for 2022 global growth to 3.4% from 4.5%. Although the views of China’s leaders on the invasion may be nuanced, it’s reasonable to conclude that their policymakers entrusted with meeting this year’s 5.5% growth target – already burdened by virus-related shutdowns and weakness in the property market – did not welcome the collateral damage of sharply rising commodity prices and slowing international trade.

Our clients’ direct exposure to China is relatively low and we believe indirect effects are likely to have a greater impact than direct exposures. Since China is the world’s second largest economy and a key linchpin in global trade, the potential indirect effects of geopolitical events involving China could have far-reaching implications in the global economy and markets. Against this background, Equity Hedging programs should be a strong mitigant against indirect risks that could lead to an equity market downturn.

Taiwan’s exposures are also low and currently not a major concern.  While we acknowledge that Taiwan will continue to face considerable geopolitical risks over the longer term, we concur with the consensus view that an invasion by China in the foreseeable future is unlikely. Correspondingly, we believe that China’s domestic economic considerations will foster policies that avoid being subject to debilitating sanctions for actions related to Russia’s conflict with Ukraine.

In general, we do not view the direct exposures in China (or Taiwan) as a significant risk to our manager’s performance – given their direct exposures are moderate at the client total portfolio level, and we do not view sanctions being imposed on China (due to invasion of Taiwan, or more outspoken support of Russia) as a base case. Indirect effects from geopolitical risks associated with China could be more concerning, so SECOR continues to closely monitor the situation.

About the author

Edgar Sullivan, CFA

Macro Economist

Anja Needham, CFA

Portfolio Manager