Understanding De-Risking and Decoupling from China

Meanwhile, in Germany: "Nearly half of German companies operating in China are taking measures to reduce the risk of doing business there largely due to growing geopolitical tensions, according to a new survey by the German Chamber of Commerce in China. Firms are building supply chains that are independent of China, shifting some operations away from the country and growing markets elsewhere in Asia...Some 83% of companies cited geopolitical tensions as the main reason for their steps to mitigate risks related to China business, while 45% and 24% respectively put it down to the country's economic slowdown and greater focus on self-reliance. Other countries are benefiting from this risk mitigation strategy, according to the survey - with 57.5% of companies surveyed saying they would be investing more in India, followed by 37.9% for Vietnam, 30.1% for Thailand, 23.3% for Malaysia and 20.1% for Singapore." https://lnkd.in/e7Q--CKa

If we value stocks by looking at earnings, we’re missing something big. Missing it for two reasons. First, what is coming down the pike has as much to do with lower risk as it has to do with earnings. Keep in mind that the value of a stock is based on earnings discounted to reflect risk. If risk lowers, then prices should go up, everything else — like earnings — given. Second, the big thing will depress earnings in the short run, over the next two to five years. So short term thinking will move you in the wrong direction. What is it? De-risking. Also known as deglobalization, friend-shoring, or, by my way of thinking, deChinaization. It is already happening. For exports and imports combined, Mexico is now the U.S.’s No. 1 trading partner, with Canada nipping at its heels. China is number three. It is 11% versus 16% for Mexico and for Canada. And the increasing trade with Mexico is in the big league categories of machinery and electronics. Why am I saying the effect of de-risking doesn’t look as great for the shorter term? Earnings will be depressed because of the cost of building the plants. And because in the interim, with lower efficiency, friend-shored production costs will be higher. More on the shift toward Mexico and Canada is in this concise Wall Street Journal article: https://hubs.ly/Q01_4g-W0 Illustration source: Wall Street Journal

Firms are actively diversifying investment and sourcing away from China, but it won't necessarily reduce reliance on Chinese inputs and suppliers in the near term. Some observers assert that diversification away from China is already well underway. Others caution that global value chains are simply too integrated to untangle and the Biden administration’s de-risking policies are unlikely to succeed. Which camp is right? Our new research note explores these issues using a wide range of available data points. Firms—foreign and Chinese—are actively diversifying investment and sourcing away from China, in sensitive as well as less sensitive sectors. Because channeling new investments to new markets is easier than finding alternative suppliers, particularly for intermediate inputs, the trend is most visible in the FDI realm.