By Tim Courtney, Chief Investment Officer
China has been making headlines recently — from the ongoing Evergrande crisis to the country’s power shortage to escalating Taiwan tensions. Understandably, it can be difficult to sift through the noise and understand which news items will have long-term market and economic implications.
We don’t believe an Evergrande default would be equivalent to the 2008 Lehman Brothers collapse and subsequent mortgage bond crisis because global risk exposure is substantially lower. There are though China-related issues that warrant close attention from markets. For one, the level of authoritarian rule displayed by the Chinese government is much higher than what trading partners had assumed and continues to increase. China has been cracking down on big tech companies, such as the rideshare app DiDi, which the government ordered be taken off Chinese app stores a day after its U.S. IPO.1
China also has many restrictions that foreign investors must navigate to own shares on the Shanghai and Shenzhen Stock Exchanges.2 Foreign companies in China must also typically work with a Chinese company partner, and can still face additional limits when it comes to investing.3 While many had hoped that China would liberalize their markets over time, these persistent restrictions increase concerns that the government is obsessed with control and less with markets and growth.
On the other side of the globe, Chinese companies trading in the U.S. may not be following proper reporting requirements. U.S. regulators claim that Chinese law bans them from looking at the audits, so there are more opportunities for fraudulent reporting.4 This is a growing concern that has raised questions about whether U.S. investors should even be allowed to own Chinese shares.
With all this in mind, plus misgivings over China stealing intellectual property, many are wondering if it makes sense to have China such an integral part in supply chains and marketing strategies. Still many U.S. companies have growth expectations that are dependent on continuing to operate within a growing Chinese economy, although that market can and does have downturns, likely most recently in August.5
All of this is causing market volatility.6 The market has discounted several companies in China as well as companies that are highly dependent upon their market. Some Chinese companies are now trading at wide discounts that could make them attractive investments moving forward in the world’s second (or third, depending how you measure) largest stock market in the world.
There will be changes in how U.S. companies do business with China going forward. Due to these issues and pandemic-related complications, companies have never had greater incentive to look at reshoring their supply chain and logistics. If they do not bring these back to the U.S., companies might consider moving to what they may consider more reliable trading partners like Mexico and Canada.
At Exencial, we do have relatively small exposures to companies domiciled in China, which we believe is appropriate given China’s larger part of the global marketplace. We continue to evaluate our expected risk and return there. If you have any questions about this, please contact your Exencial advisor.
Sources:
1. CNBC (8/18/21) — Hard lessons for U.S. investors: Chinese companies don’t make the rules in China
2. Yahoo (4/1/21) — How to invest in the Shanghai Stock Exchange
3. CNBC (5/13/21) — U.S. firms still face more restrictions in China than Chinese firms face in U.S., says business group
4. Bloomberg (8/7/20) — Money stuff: The U.S. doesn’t trust China audits
5. Bloomberg (9/13/21) — China likely suffered another economic slowdown last month
6. CNN Business (9/20/21) — Stocks tumble as Wall Street’s fears turn to China
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