Cumberland Advisors Market Commentary – China and Wall Street – Decoupling or Linking?

Author: Bill Witherell, Ph.D., Post Date: October 19, 2020
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For at least three decades, under both Republican and Democratic administrations, the United States has urged China to open up its financial markets to foreign capital and foreign financial firms. However, as part of a broader strategy to decouple relationships with China, President Donald Trump’s administration appears to want global financial firms to pull back from China.

China and Wall Street – Decoupling or Linking by William Witherell, Ph.D

This policy reversal comes at a time when China has recently made sweeping reforms to liberalize its financial market, including removing ownership on foreign financial services companies operating in China and allowing MasterCard and PayPal to enter its payment industry and Blackrock to sell its own mutual funds in China. Under President Xi Jinping, China is pressing forward with a “linking” strategy to develop increased connections with foreign financial companies. China wishes to attract increased capital inflows and to develop their bond, pensions, and insurance markets. Chinese policymakers see benefits from having domestic financial firms gain greater exposure to major Western firms. US financial firms and US investors are clearly demonstrating that they support closer, mutually beneficial relations between the US and Chinese financial markets.

The tension between the incompatible objectives of “decoupling” and “linking,” voiced in public statements made by the leaders of the world’s two largest economies, leads to fears that a financial and capital market estrangement is developing that will have negative effects for both nations. Increased competition between Wall Street, Chinese, and other financial centers is to be expected and welcomed. Developments to date, however, suggest that the two countries may avoid seeing financial relations deteriorate to the extent that relations in trade and technology have. The substantial mutual benefits to the US and China and to global financial stability from avoiding such a breakdown in relations must be apparent to policy officials.

Despite the tough political rhetoric, the financial measures taken by the US thus far against China have been limited. Mainly, the US has blocked a federal government pension plan from investing in Chinese stocks, and the US Senate has passed a bill that threatens to delist Chinese firms from US stock exchanges if they don’t meet requirements. As the government pension plan accounts for just 3% of America’s pension assets, the effect on the flow of US investments into China’s equity markets is insignificant.

The Chinese equity market has recovered strongly this year. The CSI 300 Index, which covers the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange, is up some 17% this year. The S&P China BMI Index, which covers the investible universe of publicly traded companies domiciled in China but legally available to foreign investors, is up some 23%. In comparison, the S&P 500 is up 10.3% year-to-date. The inflow of global funds into the two Mainland China markets this year has topped $26 billion.

The Senate bill, the Holding Foreign Companies Accountable Act, prohibits the securities of any company from being listed on a US securities exchange if the company fails to comply with the Public Company Accounting Oversight Board (PCAOB)’s audit for three years in a row. The bill also requires public companies to disclose whether they are owned by a foreign government. The political statements made by Senators and others when this bill was considered and passed must have concerned Chinese firms, but the bill’s impact may be limited. Most private (i.e. non-state-owned) Chinese firms will likely arrange within the time limit to meet the PCAOB standards that all US-listed firms are required to meet. There are reports that a compromise for Chinese firms is under consideration. The attractions of listing in the US will continue to be strong: namely, better analyst coverage, deeper liquidity, and higher trading volume. The number of Chinese firms listed in the US is 220, an increase over the past year of more than 25%.

The fact that the Ant Group’s IPO, which may be the largest in history, is expected to be listed in Shanghai and Hong Kong, bypassing the United States, is understandably viewed with some concern by Wall Street. A successful offering of $30 billion or more will demonstrate the capability of these markets and may lead other Chinese firms to follow Ant’s example, possibly with urging from the Chinese government. But the Ant Group is an exceptionally attractive company. On October 16 it raised the valuation target for its IPO to $280 billion. Ant views its core activity as a facilitator of e-commerce and innovative financial services. In 2019, Ant handled over 50% of China’s $8 trillion digital payments market. The attractions cited above of listing in the United States will remain powerful as long as the US does not take further actions against listed Chinese firms.

Major US financial firms are not hesitating to take advantage of the reforms of China’s foreign-ownership and market-access regulations, despite Washington’s decoupling objectives. JP Morgan is completing a $1 billion buyout of its joint-venture asset-management partner and is also taking control of its Chinese securities and futures joint ventures. These actions should make JP Morgan the first major fully foreign-owned investment bank operating in China. Goldman Sachs and Morgan Stanley have taken majority control of their Chinese securities ventures, and Citi has been authorized to serve institutional investors as the first US custody bank in China. Vanguard is shifting its Asian headquarters to Shanghai.

US institutional investors have just demonstrated their support for a continued strong linkage between the US and Chinese financial markets by ordering more than $27 billion in response to China’s first bond offer made directly to US buyers. The bond offer was for $6 billion, and the yield on the 10-year component was about 0.5 percentage points above the equivalent US Treasury. The huge China onshore bond market is estimated as the second largest globally. In contrast, the China offshore market is now small but has huge potential, as the bond sale to US investors suggests. Participating in and helping to develop these markets together with the Chinese pensions and insurance markets will become important for US financial firms.

Tensions in the relations between the United States and China will continue whatever the outcome of the elections in the US. Both sides need to dial back the rhetoric and avoid further missteps toward a new cold war and increasing military tensions. Further moves in the direction of isolationism and protectionism by the United States will continue to be counterproductive.

It is fortunate that financial relations between the US and China have not broken down in substance. Both sides have much to gain from continuing the détente that has been hard won over years. China desires continued access to US capital and to the positive contributions US firms can make to the development of its markets. As the Chinese economy continues to grow strongly and to become the globe’s largest, its financial markets will continue to grow and mature. Opportunities for US firms to earn asset management fees and securities revenue will be huge. Also, US financial firms can learn from the advances China is making in digital payments. More importantly, including China in the current global monetary system is far preferable to giving incentives to China to develop a parallel global payments system.

Cumberland Advisors is continuing to have overweight China positions in its International and Global Equity ETF Portfolios.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
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