Legendary American investor Ray Dalio caused quite a stir last month. In a LinkedIn post on 26 April, Dalio warned that he sees the United States and China "on the brink of war". Today, we contemplate the unthinkable and assess what such a war might mean for Australia and ASX shares.
Ray Dalio is one of the most successful hedge fund managers in history. He founded Bridgewater Associates in the 1970s, which was grown into one of the world's largest hedge funds today. With hundreds of billions of US dollars under its management, Bridgewater counts billionaires and sovereign wealth funds amongst its clients, including our own Future Fund.
Dalio beats the drums
Dalio has stepped back from Bridgewater in recent years. But he still aims to educate investors around the world about lessons from history. And right now, his focus seems to be on the rivalry between the United States and China. In his LinkedIn post, Dalio said the following about how he sees the future of US-China relations:
What I mean when I say that the US and China are on the brink of war is that it appears that they are close to having a sanctions war and/or military war that neither side wants but many believe will probably happen because a) each side is very close to the other's red lines, b) each side is using brinksmanship to push the other at the risk of crossing each other's red lines, and c) politics will probably cause more aggressive brinksmanship over the next 18 months.
I want to emphasize that by saying that they are on the brink, I don't mean to say that they will necessarily go over the brink. I mean to say that they are very close to crossing red lines that, if crossed, will irrevocably push them over the brink into some type of war that damages these two countries and causes damage to the world order in severe and irrevocable ways—like Russia's invasion of Ukraine did for Russia and the world, just much bigger.
Just to be clear, Dalio's definition of 'war' does not just include a kinetic war. He also canvasses the possibilities of an economic war (consisting of sanctions and other economic coercion) or a proxy war.
But let's discuss what any kind of conflict between the US and China could mean for ASX shares.
What would a US-China conflict do to the ASX?
Before we start, it is important to note that wars are abhorrent and tragic events. The human devastation and suffering they too often bring can be immense, especially for the most vulnerable. But since we at The Motley Fool are primarily focused on investing and the share market, this is the lens we will be discussing this potential conflict and its possible ramifications through.
It is my belief that any kind of conflict between the United States and China would be devastating for the Australian economy, as well as the share market. China remains one of our most valuable trading partners. The Australian economy is highly dependent on trade with China, with major exports including iron ore, gold, and food.
Australia is a treaty ally of the United States, as codified under the ANZUS Treaty. This stipulates that if either the United States or Australia is attacked by a third party, the other country is bound to assist.
Thus, if the United States is attacked by China, or drawn into a conflict, it is very possible that Australia could immediately halt the vast majority of, if not all, trade with China.
Perhaps the largest immediate casualties of this scenario would be our mining shares. BHP Group Ltd (ASX: BHP), Rio Tinto Limited (ASX: RIO), and Fortescue Metals Group Limited (ASX: FMG) all export massive volumes of iron ore to China.
That has the potential to immediately cease in the event of a war. As would any gold exports from the likes of Newcrest Mining Ltd (ASX: NCM). Our American allies would probably not take kindly to Australian gold or iron fuelling the Chinese war machine.
Miners, food producers amongst ASX shares that could suffer
Food and consumer staples companies like Treasury Wine Estates Ltd (ASX: TWE) and A2 Milk Company Ltd (ASX: A2M), which are also dependent on the Chinese market, would also feel the pinch.
But any ASX share that has any kind of major export operations or international exposure could suffer immensely, in my view.
It's not just exporters that might be in the firing line either.
Think about a company like Wesfarmers Ltd (ASX: WES). Wesfarmers owns Kmart, OfficeWorks and Bunnings. All of these businesses are heavily reliant on the Chinese economy in their supply chains.
There is a possibility that China would cease exporting products to Australia in the event of any war, just as we would halt our own exports. This would be an enormously disruptive event for the likes of Wesfarmers, along with most other ASX retailers who rely on the Chinese economy to help produce their products.
Would any ASX shares prosper?
The only companies that I might be willing to consider relatively safe from a US-China war would be those that provide essential services and don't derive any revenue from the Chinese economy. These might include Telstra Group Ltd (ASX: TLS) or Transurban Group (ASX: TCL).
There would be precious few beneficiaries in my view. But one possible company that could see its fortunes bolstered by a US-China conflict might be Lynas Rare Earths Ltd (ASX: LYC). Lynas is one of the only producers of essential rare earth metals outside China. So if the US forced its bevvy of global allies to decouple from China, Lynas could stand to benefit enormously.
But that said, there is little doubt that a US-China war would be catastrophic for the global economy, as well as Australia. Let's hope that Dalio is being too pessimistic and that these two counties can sort out their differences peacefully.
That's certainly the view of another China expert: former prime minister Kevin Rudd. Rudd has just taken up his new post as Australia's ambassador to the United States. Here are his views on the current situation, given in a recent interview with Politico, to round us out:
The challenge that we all face is to reduce the risk of crisis, conflict and war by accident. And that's why leaders in both China and the United States have been speaking about the need to stabilize and to manage this competitive relationship.
Because managing it at that level is important if you're going to reduce the risk of accidental escalation.
