China’s equity market was the world’s surprise performer, for reasons few analysts anticipated. The crowded trade at the beginning of 2019 assumed an early conclusion of a trade deal between China and the Trump Administration.

Negotiations continue to drag on, but China’s market (on the MSCI index) is up 24% this year. World trade continues to shrink and economic data continue to disappoint globally. The rest of Asia has underperformed, and Malaysia and Turkey are down. China’s bounce-back occurred despite the lagging trade negotiations and despite the trade recession and world economic downturn.

What China has demonstrated is that its palette of policy tools – monetary, fiscal, and infrastructure – is capable of replacing the lost export demand. The pain for China’s trading partners has been greater than for China itself.

Chinese imports from the US and Europe were down 20% year-on-year as of March, but Chinese imports from Asia were down 30%. That helps explain why the other Asian stocks markets performed so poorly.

China imports parts from the rest of Asia and assembles them for re-export to the United States and other industrial countries. The plunge in Chinese imports from Asia probably reflects de-stocking by Chinese manufacturers in anticipation of additional American tariffs.

South Korea and Taiwan lack China’s vast internal market. When trade shrinks, they suffer. Samsung for example showed a 60% drop in 1st quarter profits, in large part due to falling chip prices.

There may be a silver lining for underperforming Asian markets, though.

China’s price performance outstripped the rest of Asia by a wide margin. Day-to-day variation in stock market performance, though, was very similar in China, Taiwan, and South Korea – the three big tech exporters. That’s a change from past patterns.

Through a statistical technique called Principal Components Decomposition, we can identify factors that different markets have in common.

We observe that during the past six months, exposure to the second Principal Component of daily returns to emerging markets is nearly identical for China, Taiwan and South Korea, and diametrically opposed to the exposure of Brazil, Mexico and Turkey.

This is a relatively new development. During most of 2018, we observed an “Asian factor” affecting all of the Asian markets.

What has changed, I surmise, is the tariff war, which shocked the high-tech exporters in the same way. The risks arising from the Sino-American trade dispute create the same kind of volatility in Taiwan and South Korea as in China.

The same is true for Germany, which exports half its GDP.

The German market has outperformed during the past month in anticipation of a Chinese recovery, and both Taiwan and South Korea have turned in strong performances recently. The ultimate resolution of the US-Chinese trade dispute may lead to catch-up returns in Taiwan, South Korea and China-related European stocks.