Tensions between the US and China have been rising, leading to nervousness in the stock markets. What impact could events have on the S&P 500, the Shanghai Stock Exchange Composite (SSE) and Hang Seng indices?
An already fraught relationship between the US and China has been exacerbated by the Chinese parliament recently passing a security law that will limit some of Hong Kong’s freedoms — agreed between China and the UK back in 1984 — reasserting Chinese premier Xi Jinping’s authority over the region.
The rule change was proposed on 21 May. By the close of trading on 22 May, Hong Kong’s Hang Seng Index fell 5.5% since the previous day’s close to 22,930.14 points. The SSE Composite Index, meanwhile, dropped 1.9% in a day to CNY2,813.76, wiping out the minimal gains it had made since the end of April. Similarly, the S&P 500 dropped 0.8% at close that day.
In response, US President Donald Trump announced on 29 May that he would take steps to end Hong Kong’s special status, which had allowed it to remain exempt from tariffs imposed on China.
The reaction, less severe than feared, steadied both the Hang Seng Index and SSE. On 1 June, the next trading day, the Hang Seng rose by 3.4% — its biggest single-day rise since the end of March — and the SSE by 2.2%. The S&P 500’s slight increase of 0.4% was less dramatic.
Rise of the Hang Seng on June 1 after Trump announced steps to end Hong Kong's special status
What will happen next?
The rocky relationship between China and the US in recent weeks has been well documented. Trump has accused China of mishandling the coronavirus pandemic, while tension over flight restrictions between the two countries has increased. Meanwhile, the US continues to have an axe to grind with Chinese tech firm Huawei, issuing a new set of export rules on 19 May intended to limit access to US chipmakers.
There is much debate about where the tit-for-tat relationship will go from here.
Reports from Reuters have suggested that, since Trump’s speech, Chinese state-owned agricultural firms have halted the purchase of US soybeans — one of the country’s main agricultural exports — and cancelled the shipments of 10,000 to 20,000 tons of pork.
Depending on how long the trade is halted for, there could be a direct impact on the S&P GSCI Agriculture, for example, while ongoing uncertainties would undoubtedly heighten nervousness among investors, leading the wider S&P 500 index to fall back.
The other potential bad news is that the US Senate passed a bill at the end of May that could delist Chinese firms from the US stock markets. This comes off the back of an accounting scandal that has seen Luckin Coffee’s [LK] share price crater, leading the Nasdaq to notify the company of plans to delist it.
If it were passed into law, the bill would prevent Chinese companies from changing their symbol and moving to the over-the-counter market (where delisted stocks often end up), as Motley Fool contributor, Leo Sun, points out. Even if companies aren’t forcibly removed, some may choose to delist themselves anyway.
Amid the scrutiny facing Chinese firms, Hong Kong has looked to change its stock index rules to allow internet companies like Alibaba and Xiaomi  to join the Hang Seng Index. The new changes will come into effect in August.
“Investors should keep tabs on the bill's progress, but they shouldn't expect major companies like Baidu [BIDU], Alibaba, or JD [JD] to abruptly delist their shares [in the US]. Baidu CEO Robin Li already shot down rumours that the company would delist … but left the door open for a secondary listing in Hong Kong,” says Sun.
“Investors should keep tabs on the bill's progress, but they shouldn't expect major companies like Baidu, Alibaba, or JD to abruptly delist their shares [in the US]” - Leo Sun
Could the situation get worse?
It’s in the US’ interest to not let the situation escalate further, for a couple of reasons.
The first is that a number Chinese firms exiting US exchanges would hurt US investors. Google [GOOGL] and Walmart [WMT] each have a sizeable stake in JD — the pair invested $500m back in 2018. Meanwhile, BlackRock [BLK] is Alibaba’s third-largest shareholder and Baidu’s second-largest, according to CNN Business.
“The proposed crackdown on Chinese stocks will likely spark fierce protests from American companies, funds, and exchanges,” Sun argues.
“The proposed crackdown on Chinese stocks will likely spark fierce protests from American companies, funds, and exchanges” - Leo Sun
The other reason is that a continuing war of words could erode the phase-one deal agreed between the two countries at the start of the year, which had seen China pledge not to force American companies to hand over their technology for access to its market.
The coronavirus pandemic has left the phase-one deal hanging by a thread. The likes of Apple [AAPL], which obviously has a reliance on supply chains in Asia, would be directly affected if China were to cut off access to its factories, for instance.
While this is hypothetical, the volatility of the situation means the three indexes could swing in either direction, depending on what happens next.
By the end of May, the SSE Composite Index had fallen 6.8% since the start of the year, while the S&P 500 is now down nearly 2.08% for the year (through 10 June). The Hang Seng index, which has also suffered from the resurfacing of the pro-democracy protests in Hong Kong, fell 14.2% in the same period.
Fall of the SSE Composite Index from start of the year to end of May