Chinese Tech Stocks Tumble as Trump Investigates Scorched Earth Policy

This is not investment advice. The author has no position in any of the stocks mentioned. WCCF TECH INC has a disclosure and ethics policy.

With the latest round in the US – China trade war about to heat up due to the impending trade talks scheduled for October, reports have emerged that President Trump is looking for more cards to play at the talks. Specifically, the possibility of limiting US capital outflows to China and Chinese companies. This would be a major escalation of the trade war which has thus far only really seen the two countries impose tariffs on each other (albeit ones amounting to hundreds of billions of dollars). Everything else has broadly remained the status quo.

Threats of Chinese Yuan depreciation obviously crept in as we reported previously (here) along with the possibility for rare earths exports to be limited by China as alternative measures since the US obviously has more Chinese imports it can tariff than vice versa and can therefore impose greater tariffs than the Chinese can directly retaliate to. As the US will basically be tariffing everything from China by the end of the year if no progress in trade talks is made before that, this phase of the trade war feels like it is approaching its zenith and both sides need to find the tools and levers which will define the next stage if the situation can’t be brought to heel.

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China is still deep in the throes of its transition to a modern economy. Much of the economy has been liberalised and it takes an extremely naïve person to call it a communist state these days, but it is still a long way from being a free market economy. One of the areas it is trying to open up in has been allowing foreign financial investment which today is heavily restricted by a variety of means.

Hong Kong has long been seen as the gateway for the West to access China and recent overtures by the Hong Kong Stock Exchange (HKG:0388) to attempt to buy the London Stock Exchange (LON:LSE) (which itself is wrapped up in its attempt to buy the former Thomson Reuters financial services business: Refinitiv) have done nothing to dampen that although the prospect is viewed with some suspicion in the West. Additionally, China has passed legislation this year aimed at opening up the country to foreign investors which is estimated to bring in an additional $1.5 trillion over the next decade.

That, combined with Chinese companies listing on US markets such as Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU) and others, along with major index companies increasingly including Chinese companies in their indices means that China has been seeing growth in foreign investment inflows in recent years as pension funds and others look to capture some index benchmark performance and gain exposure to the major benchmark indices as well as the region which until the trade war was viewed as a high growth economy.

That may all be about to change though as the President Trump is apparently investigating ways that it can stop American money ending up in China and Chinese companies. This is said to include the possibility of:

  • Forcibly delisting Chinese companies from US stock exchanges.
  • Stopping US government pension funds from investing in the Chinese market.
  • Stopping US index companies such as MSCI (NYSE:MSCI) from including Chinese companies in their indices.

It’s not immediately apparent how Trump would go about achieving this, but the net effect would be clear as billions of dollars would no longer be available to Chinese companies. US listed Chinese stocks like Alibaba, Baidu, JD.Com (NASDAQ:JD) and Tencent (OTCMKTS:TCEHY) among others all dipped on the reports with Alibaba losing over $20 billion in market cap and finishing the day down over 5%. In addition, the Yuan slipped against the dollar further beyond the 7:1 level.

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Wrapping Up

It may be that this leads to nothing and is simply something President Trump wants to have as a card in hand to be able to throw on the table as a factor to be considered in the trade talks which are about to kick off again. It would be naïve however to think this is a bluff, the US needs a trade deal, as does China but both sides have shown repeatedly that they are willing to go to the next round and further damage both their economies as well as the wider world in the spat.

China has been broadly maintaining its holdings of US treasury notes (currently sitting at $1.1 trillion) but the federal government has been borrowing like mad so China’s holding as a proportion of the total amount of US government debt outstanding has been shrinking. A scorched earth policy of a firesale would harm China too in that the value of the bonds would of course plummet, however it’s a factor to consider given that the US repo market is currently not in great shape as the Fed has had to intervene over the last week or so given that the market is currently awash in US T-notes, it may also be that there is a weak bank somewhere but nothing has emerged yet. But this could be a last resort option to pressure the cracks that are starting to show in the US financial system.

The US is more advanced from a financial services perspective than China obviously and has been pushing for China to open up its financial markets to foreigners. These steps would reverse the progress which has been made on that front and likely lead US fund managers that currently have holdings in Chinese companies/China to consider rebalancing their portfolios. This would obviously lead to inflows likely in domestic US listed companies as well as potentially other asset classes.

There is however another angle to this conversation. The UK is currently in the midst of its long awaited attempt to exit the European Union. Assuming this goes ahead, the UK will no doubt be courting both the US and China for trade deals and given that London is (although likely to be somewhat diminished post-Brexit from a financial services perspective) still generally ranked 1st or 2nd as the financial capital of the world, the overtures from Hong Kong to London start to take on additional context in this sense and if President Trump does indeed end up implementing blocks on US money ending up in Chinese hands, Beijing may turn its eyes increasingly to London, particularly as the US becomes increasingly hostile to China and its companies (read our coverage of the Global Cyber Policy Watch lobby group's stance on Huawei and China here).