This was already a well-known risk, with the HFCAA having become law in December 2020 and delistings unlikely before 2024. However, the move this month by the Securities and Exchange Commission (SEC) to name five Chinese companies listed in New York which face this threat brought these concerns back to the forefront of investors’ minds. Separately, there have been more Chinese companies added this year to US lists which restrict their access to key equipment or technologies, particularly in the biotechnology sector.
Although it is certainly possible that a negotiated solution can be found between the Chinese and US authorities, and recent announcements suggest China is still supportive of its companies having overseas listings, it is important to remember the context is a broader trend towards financial and economic “decoupling” between China and the US. This is something which both governments, for their own reasons, have not discouraged. It is this context which has also driven concerns that potential sanctions could be imposed on China, should they undermine western efforts to isolate Russia over its invasion of Ukraine.
Energy prices
As with global equity markets, higher risk premiums as a result of the war in Ukraine have hit stock markets in Asia. However, the most direct impact of the conflict on the region has so far been through higher energy prices. Higher prices will weaken global real incomes and hence consumption, hurting demand for Asian products. China, like many Asian countries, is a net energy importer and so will also suffer from rising prices.
Higher inflation will certainly act as a headwind for Asian countries, but the region at least entered the year with inflation generally at lower levels compared to the US. Although painful for certain countries’ external accounts, and many companies’ input costs, volatility in commodity prices is a risk investors are used to dealing with in Asia and creates winners as well as losers.
What are the implications for markets?
Putting all of the above together, what is the outlook for markets? The most obvious point is that Asian market valuations look much less frothy than they did a year ago, particularly relative to global equities.
Of course, valuations scarcely matter if you believe China has become an “uninvestable” market. We don’t believe that – there are still plenty of excellent companies to invest in in China, across A-shares, H-shares and overseas, with strong management and resilient business models.
As investors, we buy companies, not countries. Although we are mindful of the impact political and macroeconomic factors can have on equities and returns, we are bottom-up stock-pickers first and foremost. We do not try to pick companies which will do well based purely on a particular macro environment which we have forecast. Rather we try to pick well-managed companies which have structural advantages allowing them to survive (and hopefully thrive!) in as wide a range of external conditions as possible.
Although we are of course looking for opportunities emerging from the market volatility, we do so cautiously given the myriad challenges facing companies operating in China. We seek companies with strong governance and the ability to earn returns sustainably above their cost of capital. Fortunately, Asia offers no shortage of such stocks, across many geographies and industries, some of which have been caught up in the market weakness offering good buying opportunities.
