Smith argued that the huge scale of additional goods China would need to import from the US should it agree to reduce its trade imbalance would ’cause serious problems for the Chinese economy’.
‘People seem to not realise that. People seem to think, it’s just going to be a deal and it’s all going to be OK,’ he said, speaking in an online presentation hosted by wealth manager Brooks Macdonald.
‘This is an economy that’s founded on productions and exports. It’s not founded on importing $1.7 trillion from elsewhere.’
Smith added that the resulting ‘stresses and strains’ would also be felt by companies and countries reliant on sales to China and pointed to one of his own holdings, Finnish elevator company Kone (KNEBV.HE).
‘If you import $1.7 trillion from America, you’re not going to be importing much from elsewhere, are you?’ he said.
‘A company that I worry about, because we’ve got it, is Kone. Kone’s biggest market is China. I would have thought the Chinese would be buying a lot more Otis elevators if this occurs.’
Smith pointed to the return of inflationary pressures as the second threat. ‘We think we can begin to see this already in our portfolio,’ he said. ‘Inflation is beginning to emerge for the first time in a decade.
‘Consumer products companies are getting price rises to stick for the first time. Wage rates are going up and the jobs market is tight in America.’
Fed to spur next leg of rally
But Smith hasn’t turned into a stock market bear overnight. Neither threat presents a risk ‘in the very near future’, he said, and the manager believes the bull market can persist for some time yet.
‘My guess is at the moment that we have more life but it won’t last forever and there’s where I think it will end, with those two things,’ he said.
Tensions between the US and China could even provide the catalyst for the next leg of the bull market in the shorter term, Smith argued, pointing to the parallels between the stock market environment last year and that in 1997 and 1998.
‘In ’97 we had the Asian crisis when a number of Asian countries ran into balance of payments, debt service and currency crises, like Malaysia and Thailand. That was followed in ’98 by a Russian default and the world’s largest hedge fund by gross assets, Long Term Capital Management, had to be rescued,’ he said.
‘But the good news is it stopped the Fed raising rates, so we had another two-year leg to the bull market. And that’s what current events remind me of.’
Fears of a trade war between the US and China today could well provoke the same response from the US Federal Reserve, he said.
‘As a result we’ll have another leg – and we’ve had another leg at the beginning of this year. We’ve got stocks up 25%, 30% in our portfolio at the beginning of this year.’
Whatever the direction of markets, Smith emphasised that he would not be investing his fund based on his ‘macro predictions’.
‘We don’t invest money on this basis at all – we try and buy good companies, he said.
And when the stock market downturn eventually comes, Smith believes he will be better positioned than those who have shirked the more defensive stocks he owns, branded expensive by their critics, for cheaper, ‘value’ stocks.
‘I think there will be a time to rotate into value if you’re attracted by that strategy. We won’t be doing it, because it’s not our strategy,’ he said.
‘But it’s certainly not now, in my view, and it’s not heading into a downturn.
‘If you think about the proposition of rotating into value, most things which are value, pretty much by definition are going to be lower quality, heavily cyclical.
‘The idea that they will in some way protect you going into a downturn… first of all flies in the face of logic to me. Secondly, if you’ve looked back through history, it’s never worked.’