Despite rising geopolitical tensions driven by the recent US visit to Taiwan, some onlookers see limited risk to markets even in the event of an actual military conflict. What say the banks?

Last week, China officially completed its military drills around Taiwan in response to US House Speaker Nancy Pelosi’s controversial decision to visit the self-ruled island which Beijing claims to be a breakaway province. Markets breathed a sigh of relief as the world dodged potential military conflict with Beijing. Her actions were instead met by the suspension of Chinese natural sand exports to Taiwan and the import blocks of Taiwanese citrus fruits, chilled white scallops, and frozen mackerel. 

Yet while geopolitical risks have undoubtedly risen, there are still signs of improving market sentiment. Some observers even claim that an actual military clash would have a limited impact on global markets and the economy. What say the banks?

Bullish on China

Despite the elevated risks, some banks are positive about Chinese markets due to optimism about improvements on the domestic front.

«[W]e stay overweight Chinese equities and forecast 24 percent potential returns over the next 12 months,» according to a note by Goldman Sachs strategists including Kinger Lau, in contrast with caution towards global equities. «But the path to get to our 12-month index target could remain bumpy until key political events in the US and China conclude and more clarity on [American depositary receipts] delisting and local regulations emerges.» 

«While we remain underweight on equities overall, we hold the view that the long-term risk-reward for Chinese equities has turned compelling,» added OCBC investment strategist Vasu Menon. «China’s economy appears to be bottoming out and starting on a path of gradual recovery; policy makers are easing both their monetary and fiscal policy stance.» 

Military Clashes Quickly Absorbed

But even in the event of a military conflict, there are some that believe that impact will be relatively limited compared to the economic conflict that could follow.

«Markets tend to absorb military clashes rather quickly, but economic clashes have the potential to play out over many months or even years,» said RBC Wealth Management in a note by portfolio analyst Kelly Bogdanova. 

«In our view, this is where the bulk of the economic and market risks related to Taiwan are concentrated. If tensions continue to escalate between the US and China in relation to Taiwan – regardless of whether a military conflict occurs on the territory – we think the risks of a damaging tit-for-tat sanctions war between the two economic giants could escalate meaningfully.»

Studying Russia-Ukraine Conflict

According to RBC Wealth Management, there are lessons to be learned from the Russia-Ukraine conflict and the real impact of sanctions against targeted countries as well as the potential to trigger subsequent shocks to the global economy.  

«Western leaders and policymakers misjudged the potential impact of anti-Russia sanctions. They have damaged Russia’s economy much less than what was intended, and they also have had a negative boomerang effect on the very countries that imposed the sanctions, especially on European economies and businesses,» Bogdanova said.

«If the COVID-19 crisis taught us anything, it revealed that countries are deeply linked through trade ties and supply chains. And we know from other crises in prior decades that countries are also linked by a complex web of financial ties. This is how the global economic system has evolved – like it or not – and damaging those links can have unintended negative consequences.»

Chinese Headwinds

Meanwhile, the Chinese market rebound has faded as of late in the midst of a number of challenges including the tech crackdown, a property crisis, and US delisting risk. More recently, five state-owned giants announced their intention to delist in New York and onlookers are carefully monitoring the prospects of interest and platform companies following suit.

«Given these internet and platform companies hold a huge amount of potentially sensitive data of hundreds of millions of Chinese individuals as well as numerous private as well as public enterprises and institutions, the plausibility of the Chinese government being willing to make a concession […] is getting increasingly slim in the midst of pervasive Sino-American strategic competition,» said Redmond Wong, Greater China strategist at Saxo Markets.

«Through the voluntary delisting of central state-owned enterprises, the Chinese authorities may have set an example for the internet and platform companies to follow.  If that happens to be the case, the share prices of these internet and platform giants will be facing more headwinds.»