Has the tech cold war between U.S. and China begun? What could this mean for the global tech landscape? And does this year’s IPO wave signal trouble for markets? Kim Parlee talks with Bill Priest, CEO and Co-CIO of Epoch Investment Partners.
Joining me from New York, Bill Priest, CEO and co-CIO of Epic Investment Partners. Bill, it's great to have you with us. You penned a piece back in December called "Trump, Tech, and Trade," where you predicted that the president's response to China's made in 2025 proclamation was going to be essentially decoupling the US supply chain from what's happening in China. What do you make of what's going on right now?
- Well, I think in many respects, one could argue that we've entered almost a new Cold War. And frankly, Kim, until I sat down there, I didn't realize that you could argue it began 30 years ago. Essentially in 1989, the Berlin Wall fell and a lot of people thought that was the end of communism and we were about to enter this incredible period of globalization, which we can talk about in a few minutes.
But was also 30 years ago when Tiananmen Square existed, and you had pretty much the ruthless put down of thousands of Chinese individuals expressing a desire for a more democratic environment. In a sense what happened 30 years ago is being replayed a little bit today, and I think in a piece that we are working on is called "The New Cold War-- The Players, the Platform, and the Stakes."
Now the players are essentially going to be China and the US, and the US is a broader definition. Think of it as the West, but it's really China and the US. These are the two superpowers of the world we live in. And the stakes are essentially the form of government and the kind of world that we all want to live in.
The issue with China has to do with this is state capitalism versus what we think of as market capitalism. Our market capitalism rule, at least in theory, is underpinned by the rule of law. State capitalism is kind of another story. The Communist Party is in charge of state capitalism.
There's a great deal of secrecy about capital allocation, and they do have the limits. They control almost $40 trillion dollars through the captive banking system to basically do a lot of one-way investments. Time will only tell if they're profitable or not. But I think you have the underpinnings of a period that's going to last many, many years.
- Do you think that people who are watching the markets really understand that this is, in fact, a Cold War and not so much about trade but more about ideology?
- I think people are slowly beginning to see that it may be more about ideology than trade alone. And you have to go back and remember China was opened by Nixon in 1972, and it joined the WTO in 2001. And I think the expectation and hope was that given that the US won World War II, we won the Cold War with Russia, that people would begin to see that this way of life, this ideology, that some of these human rights issue actually were very positive with respect to standard of living and progress and whatnot.
And I think there was a hope that if China could observe the success of the West that they would start to emulate it. But basically it just hasn't happened that way. China has never changed really its mercantilist behavior. It's really state capitalism run by the Communist Party, and you have these vast subsidies producers-- two producers that are run through state controlled banking system. And it's a lot of money. It's $38 to $40 trillion dollars.
So this is going to be a problem, and it's going to be played out in the marketplace of trade. Now, the trade war is better than a shooting war, but trade isn't going away. And it's going to be the playing field where some of these things get sorted out. One of the things-- benefits you could look at over the last 30 years is more people came out of poverty in the last 30 years than in the history of mankind, and even though we were-- we think of-- we've had a lot of wars, the reality is there have been fewer wars as well.
Now, the one thing from an economic standpoint that's happened since 1989 is corporate profit margins have doubled. If one went back and looked at margins as a corporate profit margins back in 1989, they're roughly twice what they were today. And the reason for that has really been the success of globalization, at least in terms of economics. So there were four reasons-- four reasons this happened. If you think about it, when the wall fell in 1989, you had over a billion people join our world, principally from China, but other countries in the emerging markets as well.
So you virtually doubled the world's labor force, but these people brought no money and no technology to speak of. So you had this giant labor arbitrage develop, and you had these very sophisticated supply chains. And these were two very important factors in the expansion of margins and return on capital.
The other two things that happened where interest rates fell down considerably from that period, as are tax rates. So if you really are in a Cold War that'll be played out in trade, the biggest danger is this law of comparative advantage that was so helpful in the last 30 years, that movie will be run backwards, and the pressure on corporate profit margins will be substantial.
- Tell me a bit more. I've only got about a minute here before we go to break, but what a substantial mean? You talked about corporate margins doubling over that time period because of trading taken away. Does that mean they go in half?
- I'm not sure they go back in half, but they will start to come down. Anyone that relies on a global supply chain is in the process of reconfiguring how it might work. And if to the extent they can move some of that supply chain out of China to other countries, it could be Vietnam. It could be other countries. They will do so.
But you're also going to see some more of it brought home as well. And that will have-- there'll be an inefficiency associated with that. It may have some benefits. But you're going to watch margins get squeezed. What I don't think this administration fully understands is that the law of comparative advantage is very powerful. It's a 200-year-old economic law, and it really is win-win.
Even if a country is in every category less efficient than a trading partner, it still may pay to trade with them because it's about the relative difference, not the absolute difference. But we're in the process of winding that law comparative advantage movie backward, globalization backward. And I think you're going to watch this-- it's going to put tremendous pressure on margins and subsequently profits.
- Bill, we were talking about the not trade war but really a Cold War you believe that's starting up between China and the US. Any follow up before we move into some of the IPOs that they're coming into the markets?
- I think what we're witnessing is a fundamental clash between two economic systems and two economic superpowers really. And as many others have pointed out, this clash has been made more combustible by politics and a atmosphere of mistrust. A fundamental principle of trade demonstrates that trade relations really rely on companies to have a shared vision of commerce. If you don't have a shared vision, it's a problem. And even if you do have a shared vision, you have to sign up for a group of laws or rules that will adjudicate disputes.
And what we have here is, there's just no way-- and China emphasized this over the summer-- over the past weekend-- there is no way they're going to give up anything with regard to what they think is their value system.
- Well, I guess this is the understatement. Buckle up. There's some bumps ahead on this front. It's not going to get easily solved. Let me ask you, there's a whole bunch of companies that have gone public in the wake of all this turmoil that's happening from a trade standpoint, but you've got the Ubers, the Lyft, Beyond Meat, We Work, Pinterest, Slack. What do you think is fueling this IPO wave, and what do you think of the companies coming out?
- Well, I think the wave is fueled by a number of things. First of all, money is really, really cheap, so you have very cheap money. You also have an agency principal problem in the sense that the agents are spending the money of the principals. All that said-- and I think it was captured very well in a recent "Economist" cover called "The Trouble with Tech Unicorns--" and a unicorn is defined as a company that's worth a billion dollars, and it's private. There's-- there were 135 unicorns in existence. In 2013, there were only 38.
So you've had a robust increase in uniforms. The business models that many of these have do not include profits in the near term. There's something called blitz scaling. There's even a book out about it. And what it's about, it's about how quickly you can take an idea and blitz scale it to the point where you have a digital moat where you basically have a winner take all with regard to future profits.
All of these models have what's called a two-sided model. The way to think about it, think about ridesharing, for example. There's only going to be one or at most two ride sharing companies but probably just one, and it's going to rely on density. So the more users you have in terms of using cars, the more suppliers you're going to have. The more suppliers you have, the more liquid the ride's going to be, and you're going to have more users. So you want to get there as fast as you can. So people are spending enormous amounts of money to get to the end game, which is essentially a winner take all market.
You can see this being played out in ride hailing. You can see it in a few other places as well. But it's grow as fast as you can, technology is your friend, there's lots of uses of cloud computers. Smartphones, social media, and low interest rates have all combined to create this incredible IPO market. Only 15% of IPOs this year are going to even be profitable, and 40% of this offering has dual shares-- AB shares. So we'll see how this plays out, but I don't see any reason why as long as you have cheap money, low rates, and the agency spending the principal's money, it still looks like it's going to go on for a while.
- I wonder, though-- I've only got about a minute here, Bill, but I wonder if a market turn could change all that because again we know lots of people talking about if trade and a Cold War as you talked about come out, you get something like a recession. How does that change that market?
- The market-- I'm not-- it's very difficult to have a recession in the United States if you think of recession being defined as two negative quarters of GDP. The workforce is growing, albeit slowly. Productivity is growing albeit slowly. I don't see how that's going to change very much.
The change is going to come in profitability, and I think that will start to show up in the second half of this year. I think as you go into the second half of this year, particularly with some of these industrial companies, you may very well see guidance come off. As they talk about their year in the future, you may well see that comes off.
So when you look at the components of return, it's just earnings, dividends, and P/E ratios. Now, P/E ratios could easily start to contract a little bit. Earnings will be under pressure. I think dividends will be surprisingly good, but it won't be enough to offset I think the pressure from earnings in multiples. But I think the second half is going to be volatile, and I think people are just beginning to understand this trade war is not just about two principles with big egos. This is a fundamental clash of two superpowers, and it's being played out in trade.
- Bill, always a pleasure. Come back up to Toronto where we can talk in person. It was great to talk to you.
- Thank you very much.
- Bill Priest. He is CEO and co-CIO of Epic Investment Partners, joined us from New York.