- MemberMay 27, 2020 at 8:54 pm
Sorry, this is a long one!
Recently, tensions between U.S. and China are at the highest since the last decade. The U.S. has retaliated in a couple ways so far…accusing of China covering up COVID-19, delisting Luckin Coffee (Holding Foreign Companies Accountable Act) and the extradition trial with the Huawei CFO.
Most recently, the conflict between the U.S. and China is centered around Hong Kong, which is currently losing its autonomy from China. Pompeo, the Secretary of State, recently announced that “No reasonable person can assert today that Hong Kong maintains a high degree of autonomy from China, given facts on the ground.” The market believes that the trade deal established with China will be preserved, since it is in both parties economic interest. I agree, and the markets have responded well. Others argue that Trump’s anti-China rhetoric is all bark and no bite. However, the problem of maintaining Democracy in HK has now emerged as a bi-partisan issue. As a result, Chinese equities listed on the Hang Seng have been mildly punished.
While it is rare, I think this may be one of the few instances where political actions will be done with severe economic consequences for both parties. The problem is that there is no true resolution to this issue for HK: if HK loses its freedom (extradition treaty), its role as a financial hub diminishes. If it continues to riot and protest, it continues to lose its capital (the wealthy are already fleeing). The future of the Hang Seng Index is unclear.
FXI tracks the 50 largest Chinese equities that trade on the Hang Seng. Its largest Holdings are Tencent, China Construction Bank, Ping An Insurance, Meituan DianPing, Industrial & Commercial Bank of China, China Mobile and Bank of China Ltd (~50% of total).
My thesis is that the continued escalation of these tensions will result in conflict surrounding foreign investment, with sanctions and limitations on investments that may directly support the CCP. A near term catalyst would be Trump announcing a response to HK this week. A longer-term catalyst would be Trump’s anti-China reelection campaign. One potential result would be capital outflows from Chinese companies that are CCP owned, which are Chinese financials. The four major state-owned banks make up 21% of the FXI ETF.
A risk I should address is that this ETF will rise if China continues its rapid recovery from the COVID-19 crisis, and if Trump’s anti-China rhetoric is actually all bark…and no bite. Would love to hear everyone’s thoughts on this.
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