An investor looks at screens showing stock market movements at a securities company in Nanjing in China's eastern Jiangsu province
STR/AFP via Getty ImagesInvestors may want to wait before hopping on recent weakness in some Chinese stocks. One reason: analysts expect more China-related measures into the last weeks of the Trump administration that could create near-term volatility—and better buying opportunities.
Chinese internet stocks already have taken a hit in recent weeks, with Alibaba Group Holding (BABA) down 11% in the last two weeks while JD.com (JD) is down 6%. Better-than-expected news about a vaccine fueled a broader rotation out of recent winners—like Chinese stocks, especially technology—into those that have lagged behind and could benefit as the world gets back to some level of normal.
But Chinese stocks have also been weighed down by regulatory risks in China amid the scuttled public offering of financial-technology juggernaut Ant Group and new guidelines targeting China’s internet platforms. And then there are China-related measures coming out of the Trump administration in its last weeks, including a recent executive order barring U.S. investments in 31 Chinese companies the Defense Department deems as having ties with China’s military, and a continued push among regulators and Congress to delist Chinese companies from U.S. exchanges if they don’t comply with auditing rules.
More measures could come into inauguration. The addition of international trade lawyer Corey Stewart to a senior post in the Commerce Department could be a way to help the outgoing administration push through hard-line policies on China before January 20, says Anna Ashton, senior director of government affairs for the U.S.-China Business Council.
Possible measures could include additional executive orders, possibly involving export controls or blacklisting high-profile Chinese companies through the so-called entity list, which can restrict U.S. firms from selling to them.
The moves could create headline volatility though there is skepticism about lasting impact. “The outgoing administration is looking for things they can put in place that will tie the hands of the incoming administration. That is difficult to do,” says James Green, a former senior official at the U.S. Trade Representative who is now a senior advisor at McLarty Associates. The legal and implementation challenges related to recent orders like the threatened bans against Tencent Holdings ’ WeChat app and ByteDance’s TikTok has shown some of the possible complications.
Also a hindrance: There is not much time left to implement changes, one reason Derek Scissors, resident scholar at the American Enterprise Institute focused on China, describes moves to add more companies to the entity list, for example, as “posturing, not genuine action.”
But sources for near-term volatility persist, especially amid a continued push to delist U.S.-listed Chinese companies not in compliance with U.S. auditing rules after a certain period—addressing a longstanding issue around transparency. The Senate has already passed a bill; the House has yet to pass it, but some policy-watchers have identified it as one of the measures that could move before year-end.
The Securities and Exchange Commission is also considering a delisting measure, with the Wall Street Journal reporting this week of a draft proposal that could require Chinese companies listed in the U.S. to use auditors under the oversight of U.S. regulators or risk exchanges kicking them off. Not complying with audit inspections could also keep Chinese companies from listing in the U.S.
There are roughly 190 Chinese companies with American depositary receipts, or ADRs, according to BNY Mellon. Eight of the companies listed in the U.S., including some of the most widely held Chinese stocks, have already sought secondary listings in Hong Kong and many fund managers have swapped into those local shares. Alibaba, JD.com, NetEase (NTES), ZTO Express (ZTO), New Oriental Education & Technology Group (EDU), GDS Holdings (GDS), Zai Lab (ZLAB) and Baozun (BZUN) are among the companies with American depositary receipts that have secondary listings. Multiple state-owned enterprises like China Life Insurance (LFC) and PetroChina (PTR) have dual listings as well.
Exposure to ADRs differs among popular ETFs. Four of the top 10 holdings of the iShares MSCI China ETF (MCHI) and SPDR S&P China ETF (GXC) are held in ADRs while seven of the top 10 holdings of the KraneShares CSI China Internet ETF (KWEB) are U.S.-listed shares, says Todd Rosenbluth of CFRA Research.
While these measures could keep Chinese stocks volatile, the longer-term fallout is still unclear. Take the executive order that bars U.S. investors from transacting in securities of companies the Defense Department deems as having ties to China’s military, effective Jan. 11, though investors would have until November to divest securities they own.
The order could apply to 16 issuers or subsidiaries that are part of JPMorgan’s credit indexes but the bank’s global index research team, in a note to clients this week, outlined the uncertainty around the measure, including whether restrictions apply to subsidiaries, the impact on international broker-dealers and what that could mean for the liquidity of some of these bonds.
Also unclear: What approach the Biden administration takes—and where China ranks in its priorities as it grapples with the pandemic. The U.S.-China relationship has changed over the past couple of years, increasingly viewed through the lens of competition and conflict—and that could continue in a Biden administration. But analysts expect a more multilateral and cohesive approach that could mean less of the tit for tat that rattled markets in recent years.
About 63% of U.S. companies doing business in China said they were “more optimistic”—or “much more optimistic”—about operating in China after the election, according to a survey released Friday by the American Chamber of Commerce in Shanghai. Though more than half surveyed had no plans on increasing investments in China, 82% of those with manufacturing operations in China said they have no plans to move that offshore in three years.
“Simply not calling China an enemy will take the chill off the relationship, creating space for both Biden and [President] Xi to consider what concrete steps they are willing to take,” Andy Rothman, Matthews Asia investment strategist said in a note to clients. Rothman expects a near-term modest improvement in the relationship that should give investors more comfort than they have had in recent years.
For those looking to add to Chinese holdings, volatility in coming weeks could eventually be an opportunity.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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