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The US Listed Chinese ADR is Dead, Invest in the Mainland Instead

Staying on the subject of last week’s article on China, a risk of late is that the direction of travel is for a growing separation between the Chinese and American stock markets  in what looks to be ongoing fallout from the continuing escalating tensions between Beijing and Washington.

It has become self-evident that China is increasingly wary about Chinese companies listing in America.

In this respect, Beijing has announced plans to tighten restrictions on overseas listings of Chinese companies.

For example, the Cyberspace Administration of China announced in July that companies holding data on more than 1m users must now pass a cybersecurity review before seeking overseas listings.


This is in addition to the existing threat posed to Chinese companies already listed in America in terms of conforming with American accounting regulations, a task it is impossible for them to do without breaking legal requirements in China.

On this point, the US Senate passed on 22 June the Accelerating Holding Foreign Companies Responsible Act which requires Chinese ADRs, and other foreign companies, to comply with the Public Company Accounting Oversight Board (PCAOB) audits within two consecutive years instead of three previously.

This suggests that all the US listed Chinese companies will need to delist in America sooner or later; and relist in Hong Kong and/or China.

So far 16 have already done secondary listings in Hong Kong with many more expected to follow.

This need not be disastrous.

There are, for example, only 13 Indian ADRs listed in America, compared with 248 Chinese companies.

But it does mean that foreign investors are advised going forward to own Chinese companies quoted in Hong Kong and China rather than in America.

Meanwhile the potential risk is that the longstanding questions about the merits of owning so-called variable interest entity (VIE) structures, which are not pure equity, finally come home to roost.

Under the VIE structure an investor has a claim on the profits of a business without owning the underlying assets.

In this respect 16.2% of MSCI China is currently represented by Chinese stocks quoted in America and about 46% is represented by VIE structures, including the big ones listed in Hong Kong such as Alibaba, Tencent, Meituan and Xiaomi.

The Search for the Source of COVID-19 Continues

Meanwhile there is the potential for a major further escalation in tensions over the potential explosive issue of the Wuhan lab leak theory.

US President on 26 May gave the US intelligence agencies 90 days to come up with a definitive view on whether the Covid virus leaked from the lab.

But reports from Washington last week indicated that the delivered report failed to come up with a definitive conclusion with the failure blamed on a lack of Chinese cooperation.

Still, whether this issue will be quietly shelved or not remains far from clear.

If there is  real escalation on this highly emotive issue, it is likely to make life potentially uncomfortable, from a domestic US standpoint, for American corporates with longstanding investments and successful businesses in China, a country which in 2019 before the pandemic accounted for 29% of world GDP growth on a PPP basis.

China’s share of world GDP growth (PPP basis)

Source: IMF

But from a mainland standpoint China continues to do nothing to make life difficult for American corporates operating in China because it wants the foreign investment.

This is sensible pragmatism from a Beijing perspective.

If  the bilateral tensions continue to escalate and the agenda of the national security hawks in Washington ultimately prevails, in terms of strategic competition turning into outright economic warfare, it should never be forgotten that China, based on the most recent data, still owns US$1.06tn of US Treasury securities though down from a peak of US$1.32tn in November 2013.

That constitutes a certain degree of leverage.

China holdings of US Treasury Securities

Source: US Treasury

But such dire outcomes are not, for now at least, this writer’s base case.

Chinese Economic Conditions Remain Healthy

Meanwhile China’s economic condition remains fundamentally healthier than many commentators make out.

Still China signalled last month an easing of policy in terms of the RRR cut announced on 9 July.

This means that the trend of recent months of slowing money supply and credit growth should, at a minimum, flatten out.

Consumption growth has not yet recovered to its pre-Covid levels, most particularly spending on services, despite healthy income growth.

Total consumption expenditure per capita rose by a two-year annualised 5.4% in 1H21 (vs 1H19), compared with 7.5% YoY in 1H19.

While disposable personal income per capita has increased by an annualised 7.4% over the past two years to 1H21.

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China consumption expenditure per capita growth by sector

Source: National Bureau of Statistics

The relative softness of consumption is despite the fact that the Chinese are no longer travelling abroad and they used to spend around US$260bn a year overseas before the pandemic.

China outbound travel spending

Source: State Administration of Foreign Exchange (SAFE) – Balance of Payments data

Still, like many other countries, a proper consumption recovery will likely hinge on a fuller vaccine rollout leading to increased confidence that so-called herd immunity has been reached. 

As of 26 August, 889m people are fully vaccinated which is 63% of the population, according to the National Health Commission.

That suggests, based on the available data, another 225m or 16% of the population have received one dose of vaccine.

If China’s current vaccination rate of 14m jabs a day is maintained, then all of the population should be fully vaccinated by late October.

It is also the case that Beijing is already preparing for booster shots with Fosun Pharma expecting to be producing 1bn doses per year of the Pfizer-related vaccine by the end of this year at its Shanghai plant.

The application of those booster shots may also be the time when China becomes more willing to open up its economy again to the outside world.

Meanwhile if the infectious Delta variant has arrived in China, it looks for now to be under control.  

New daily Covid cases in China are down from a recent high of 143 on 9 August to 21 on 27 August with no new death reported since late January.

China daily new Covid cases

Source: National Health Commission

Look for a Pickup in Infrastructure Investment Over the Next Six Months

If a broader consumption recovery should only be a matter of time, in addition to a less restrictive monetary policy, the second half of this year is also likely to see a pickup in fiscal support in terms of government-led infrastructure support.

There is also growing potential for an acceleration in the private investment capex cycle in China.

In this respect, China is similar to America and Europe where the prospects are also growing for politically driven capex investment cycles, be it so-called Green New Deals in America and the Eurozone, or in the case of China driven by the perceived imperative to upgrade the economy and secure technological independence.

In the case of China there is already initial evidence of this in the sense that manufacturing investment in the first seven months of this year.  

Total fixed asset investment rose by 10.3% YoY in January-July 2021 while manufacturing investment increased by 17.3% YoY.

China total and manufacturing fixed asset investment growth (year-to-date)

Source: National Bureau of Statistics

This outlook suggests that China growth will again become more domestic demand driven in coming quarters after the role played by exports post the lockdown in the first quarter.

China increased its share of annualised world exports to a new all-time high of 15.6% in the 12 months to February 2021.

It was 15.2% in the 12 months to May.

China’s share of annualised world exports

Source: IMF – Direction of Trade Statistics

China is Now Exporting Inflation, not Deflation

Still the difference from the past is that China, backed by a strong currency, will increasingly be exporting inflation to the rest of the world and will no longer be a deflationary force on the world economy.

The data is already showing evidence of this.

The US import price index from China rose by 3.7% YoY in July, the highest level since November 2011.

US import price index for China %YoY

Source: US Bureau of Labor Statistics

That is not to say that China has an inflationary problem.

Consumer price inflation remains subdued, reflecting the conservative monetary policy.

Headline CPI and core CPI rose by 1.0% YoY and 1.3% YoY respectively in July.

China CPI Inflation

Source: National Bureau of Statistics

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.

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Categories: Global Strategy
Christopher Wood: Chris is internationally renowned for his weekly institutional research newsletter GREED & fear. He has correctly identified all major global financial bubbles over the last 3 decades (US sub-prime crisis, Nasdaq technology bubble, Asian financial crisis, and the Japanese financial meltdown). He’s also the author of three highly acclaimed books: Boom and Bust, The Bubble Economy, and The End of Japan Inc. Since May 2019, Chris has been Global Head of Equity Strategy at Jefferies.
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