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Is America’s loss, Europe’s gain when it comes to China?

At the end of last month, the EU signed its first significant bilateral trade pact with China.

It was a notable contrast to the deteriorating relationship between China and the US and appeared to signal the advent of closer ties between the two vast trading powers.

It started to appear that, far from being a victim of the US/China trade war, Europe might actually benefit from it.

If so, does this spell good news for economic growth – and equities – across the region?

Significant sums

For China, the deal was almost certainly indicative of its desire to move away from economic reliance on the US.

The EU is a vital pillar in China’s post-Covid recovery strategy and strengthening ties makes sense.

The question for European investors is whether it will provide a similar boost for European companies in this all-important recovery period.

This seems likely.

China total trade with the EU (including the UK) is more than $650bn (€545.5bn) per annum, or $560bn if the UK is excluded.

An economy roughly the size of Sweden is exchanging hands every year between those two regions.

The EU (even without the UK) shares the top spot as China’s biggest trading partner with the US.

Thorny issue of Huawei 

As such, the recent strength in China has been a boost for the EU economy as well.

George Lagarias, chief economist at Mazars, says: “China’s rebound, at least on paper, has been remarkable.

“According to official sources, second quarter GDP completely made up for the Covid-19 related shortfall in the first quarter, and the country hasn’t seen a virus resurgence that we are now seeing in other parts of the world.

“Europe will benefit is in as much as its supply chains are repaired, as China will improve from eventually resurgent European demand.”

Certain areas are particularly important: cars, for example, remain the largest EU export to China, with pharmaceuticals and aircraft also key export areas.

At the same time, China is reliant on the EU buying its telecom equipment.

The recent controversy over 5G continues to pose a problem for EU/China relations.

Emmanuel Macron, president of France, recently announced that French telecoms networks will be free of all Huawei influence by 2028 at the latest but appears to have dodged the wrath of Beijing for the time being.

Self-interest

Eurozone policymakers have previously said that Beijing’s enthusiasm for trade agreements has often increased as China’s economic relations with the US deteriorated.

Kristina Hooper, chief global market strategist at Invesco, said Europe may benefit in other ways as well: “The US might want to ratchet up tensions with countries beyond China.

“The rationale would be that it is politically expedient to pursue ‘trade fairness’ in an election year, but the US does not want to anger China so much that it hurts the US economically, so it may prefer to turn to other countries, especially Germany.”

Lagarias believes Europe may have the edge over the US on long-term relations with China: “I believe that Europe, influenced by the German ‘Realpolitik’ doctrine, is playing the long game with all its major partners and seeks to maintain balanced relationships based on long-run mutual interests.

“In the past, overtures would have been restrained due to Nato concerns. But the receding of US influence in global affairs over the past few years creates an opening for closer cooperation between Berlin, Paris and Beijing.”

This suggests that Europe may benefit even if US leadership changes and shifts stance after November’s election. The Democrats are equally anti-China even if their approach may be more moderate.

Friend or foe?

Another risk is that the US may make a fuss about closer ties.

The EU will need to be sensitive to the wishes of its largest trading partner.

However, the US cannot bully the EU in the same way it can smaller countries and trading blocs because of its relative strength and influence.

It is also clear that there are areas where the EU is attempting to build its own capabilities and this may be a source of tension.

It is clearly uncomfortable outsourcing production of car batteries for its domestic car fleet to China.

Instead, it has sought to bring production closer to home with two new gigafactories – one in Sweden and one in Germany.

The relationship between the two trading blocs is always likely to be a sensitive one.

Local focus

What does this mean for stock markets?

There are certain parts of European stock markets that are particularly sensitive to Chinese growth: the Chinese market is particularly important for German multinational corporations such as Siemens and Volkswagen, for example.

Motors, luxury goods, pharmaceuticals are all beneficiaries of stronger relationships between China and the EU, and a stronger Chinese recovery.

However, while European stock markets will often ebb and flow with China data, in the longer-term the domestic economy is always likely to be more important.

Lagarias says: “Ultimately, European companies might see increased exposure to Chinese consumers, but their focus, as a predominantly service economy, will remain local EU markets.

“No matter what the approach to Beijing, I would expect gains, or losses for that matter, to remain a marginal consideration for the profitability of European equities.”

Part of the Bonhill Group.