Managing The Dragon’s 2020 Predictions

While the Phase One Agreement (the “Agreement”) signed by U.S. President Donald Trump and China’s Vice Premier Liu He on January 15 represented a promising start to the New Year, the outbreak of the coronavirus in Wuhan and surrounding Hubei Province quickly stole the spotlight. Reports of its spread have dominated the news ever since, and it now seems as though the virus, along with progress in the ongoing trade negotiations between China and the United States, will share the headlines in 2020.

As the year progresses, economists, businessmen, politicians, stock market analysts and consumers from both countries will be watching — and reacting — to reports about the virus and its impact on the Chinese economy and the country’s position in the global supply chain. They will also be watching for signs that Phase One is being implemented and that Phase Two will be successfully completed.

While there are many unknowns surrounding the coronavirus, and MTD is not qualified to make predictions on it from a medical point of view, our five predictions for 2020 must necessarily take into account the fact that the virus will adversely impact all things China for a substantial portion of this year.

Prediction #1: The Phase One Trade Agreement will be successfully implemented in the New Year, and an agreement on Phase Two will be reached by year-end.

Analyses of the Phase One Agreement (the “Agreement”) vary widely. Some argue that the United States achieved very little in the Agreement, and that China is unlikely to come through on its commitment to purchase $200 billion of U.S. services and agricultural, manufactured and energy products over the next two years. At the same time, others liken the Agreement to the one sided treaties forced on China by foreign powers during the country’s “Century of Humiliation.” Given the differences of opinion on the subject, it is best to go directly to the source.

Based on a reading of the Agreement, MTD’s opinion is that many of its provisions are quite favorable to the United States, suggesting that China was anxious to complete the deal. Moreover, the Agreement contains a sensible dispute resolution mechanism that calls for quarterly meetings between the United States Trade Representative (“USTR”) and a Chinese Vice Premier in order to monitor implementation and to discuss and resolve any violations. As far as the $200 billion of additional imports of U.S. goods and services are concerned, China has the ability to effect such purchases through its large state-owned enterprises, and the country is a net importer of agricultural products and energy. The quarterly meetings will create an ongoing dialogue between the two countries and help ensure that the provisions of the Agreement are implemented, including the additional purchases by China.

China needs to stabilize its economy, which is even more important now that economic pressures on the country are being exacerbated by the coronavirus. Removing the overhang of a trade dispute with the United States will help to offset some of the adverse impact of the virus, and removing the 25 percent tariffs on $250 billion of its exports to the United States will be a welcome external stimulus to its economy. China has every incentive to implement Phase One and reach agreement on Phase Two. Meanwhile, President Trump would like to chalk up a larger deal with China as another “win” before the November election.

Prediction #2: During the first half of 2020, negative news about the coronavirus will cause the renminbi, China’s currency, to trade in the range of 6.75 to 7.2 to the US dollar. In the second half, MTD predicts a trading range of 6.5 to 7.0 to the US dollar.

Two days before the Phase One agreement was signed, the United States announced that it would withdraw its designation of China as a currency manipulator. Reaching an understanding on currency was obviously important to completing Phase One, which is why an entire section in the Agreement is devoted to the currency issue. As a result, it is reasonable to assume that the exchange rate between the yuan and the dollar will be closely watched and any evidence of devaluation will be a subject for discussion at the quarterly meetings between the USTR and China’s Vice Premier.

Over the past five years, the yuan has been relatively stable, trading in the range of ¥6.5 to ¥7.0 to $1 for most of the period. Other than a number of months in 2015 and a brief period in 2018 when the currency traded as low as ¥6.0 to the dollar, and three months in 2019 when it traded above ¥7.0 to $1, the yuan has been between ¥6.5 and ¥7.0 to $1. MTD predicts that China’s currency will trade in this range during the second half of the year, when hopefully, the spread of the virus has subsided.

During the first half of 2020, MTD expects that news about the coronavirus may cause China’s currency to trade higher than ¥7.0 to $1.0. In 2019, when trade negotiations between China and the United States were at their rockiest, the renminbi never traded above ¥7.17 to $1. Therefore, MTD predicts a range of ¥6.75 to ¥7.2 during the first half of 2020 when news about the virus will likely be at its worst.

Prediction #3: The Shanghai Stock Exchange Index (“SSE”) will recover somewhat in the second half and end the year at or above 3200, a modest 5 percent increase for the year.

In the first draft of its 2020 predictions, before the coronavirus became front and center, MTD was prepared to predict that the SSE would recover the rest of the ground it lost in 2018, and end 2020 at or above 3,300. However, when the China stock market re-opened on February 3 after the Spring Festival holiday, the SSE fell almost 230 points (7.72 percent) to 2,747 in its first day of trading. Until new cases of the virus begin to subside, the negative news will continue to dog China’s stock market performance. As the year progresses, news of the virus will hopefully turn more positive; there is likely to be continued progress on the trade talks; and the stimulus measures that China is implementing will begin to take effect. As a result, China’s stock markets will recover and end the year five percent higher.

Prediction #4: Auto industry sales in China will continue to decline in 2020, falling a further 2.0 to 5.0 percent during the year.

As evidenced by the views expressed by the leading authorities on the subject, China’s auto industry is in new territory, and no one expects the industry to return to the heady growth of the past 20 years.

Bearing in mind that most observations about the industry’s prospects in 2020 were made before coronavirus came on the scene, following are a few examples of what the experts are saying. Miao Wei, Minister of the Ministry of Industry and Information Technology (“MIIT”), which is responsible for the regulation and development of the postal service, internet, wireless, broadcasting, communications, production of electronic and information goods, the software industry and the promotion of the national knowledge economy, is the most positive. Minister Miao Wei said that the development of China’s automobile industry has entered a period of adjustment; that the market has gradually bottomed out; and that auto production and sales will tend to be stable in 2020.

Lang Xuehong, Deputy Secretary-General of the China Automobile Dealers Association, predicted at the end of November that the automobile market will continue to bottom out in 2020 and that auto sales will be down 10 percent this year. Officials at the China Association of Automobile Manufacturers (“CAAM”) are less pessimistic. CAAM has predicted that the decline in China’s automobile market will narrow to 2 percent in 2020, and that the industry is in the process of transitioning from quantitative growth to high quality development.

Apart from adverse economic influences; the negative impact on consumer confidence by the trade dispute; and most recently, the coronavirus, structural changes in China’s auto industry are also putting a lid on growth. Many large Chinese cities have now limited new auto licenses in their cities, forcing automakers to look for new demand in the country’s lower tier cities.

Also, with a car population of over 250 million vehicles, used car sales are now growing and taking a larger share of new demand. While new car sales in China declined by 9.6 percent to 21.4 million in 2019, used car sales grew by an estimated 5.6 percent to 14.6 million. As an indication of how large an impact growing used car sales will have on China’s auto market, used car sales are more than double new car sales in the United States.

Taking all factors into account, MTD believes that new car sales in China will fall a further 2.0 to 5.0 percent in 2020. Putting the numbers aside, look for automakers to search for new ways to market cars and to reach consumers in lower tier cities in the New Year. The innovative experiential marketing program that Borgward is implementing in conjunction with UCAR, China’s leading car rental platform, is a case in point.

Prediction #5: New Energy Vehicle (“NEV”) sales in China will resume growth, with sales increasing by 20 percent in 2020.

After years of high double digit growth, sales of NEVs, which include battery electric vehicles, plug-in hybrids and fuel-cell cars, reached 1.3 million units in 2018. In combination with the worst China auto market in decades; the substantial reduction in consumer subsidies for NEV purchases; and new regulations that shift the burden of subsidizing the price difference between NEVs and cars powered by an internal combustion engine from the government to the automakers, sales of NEVs fell by four percent in 2019.

China has over 100 cities with a population of one million or more, compared to ten in the United States. With so many highly congested cities, China has to search for new ways to develop its automobile industry, which is why the government has promoted heavily the production and sales of NEVs. China is transitioning the way in which it promotes NEVs and sales suffered as a result in 2019. Notwithstanding the decline experienced last year, the case for NEVs remains as strong as ever. As a result, MTD expects the Chinese government to make whatever adjustments are necessary for growth to resume.

While MTD is not predicting a return to high double-digit growth, a 20 percent increase in NEV sales in 2020 seems reasonable.

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