If you focus on inflation and Fed policy, you may have missed a key breakthrough in U.S.-China relations that will drive U.S.-listed Chinese stocks over the next six months.
The Ghost of Enron
Years ago, after the tech bubble burst in 2000, U.S. auditing firms came under fire for not publicly reporting accounting shenanigans that cost investors a lot of money— —Including Enron, the poster child for the collapse of that era. In response, Congress created an auditor called the Public Company Accounting Oversight Board (PCAOB). The Chinese government has never given American inspectors a peek at the books of Chinese companies for fear of revealing state secrets in its large state-owned enterprises. A few years ago, Congress said enough was enough and passed a law that said Chinese companies would be kicked out of U.S. exchanges if they didn’t get involved sooner. The standoff ended on Aug. 26 when the China Securities Regulatory Commission and the U.S. Securities and Exchange Commission (SEC) agreed on an audit agreement. “I always believed they would make a deal because it is not in China’s interest to lose access to the world’s largest financial market,” Loncar said. But the devil is in the details. So it remains to be seen how much cooperation U.S. regulators will get later this year when they try to conduct inspections. “Whether these audits will go smoothly remains a question,” Loncar responded to the SEC’s cautious comments. SEC Chairman Gary Gensler warned that the agreement “only makes sense if the PCAOB is truly able to conduct a full inspection and investigation of audit firms in China.” This remains an open question for U.S.-listed Chinese stocks, as no one knows for sure the outcome. But, like Loncar, I believe it will be successful. “Despite China’s controversy,” Loncar said, this week’s breakthrough “shows that China still wants to be part of the global financial community.” It seems unlikely that China will signal cooperation, only in the future change direction. This became apparent later this year when U.S. inspectors attempted to conduct audits, which should boost U.S.-listed Chinese companies. Here are my three favorites.
If the US needed a brand ambassador to win over the average Chinese citizen, it would probably be worse than nominating Yum. Its KFC and Pizza Hut locations are very popular there. Now Yum is launching Taco Bells. Yum has also developed several fully owned emerging brands. All this makes Yum China the largest restaurant company in China. It operates more than 12,000 stores in 1,700 cities, including 8,400 KFC and 2,600 Pizza Hut. Owning Yum is more than just a bet that a tricky international accounting problem gets solved. It’s also a bet that Covid will eventually take a back seat – spreading in various less pathogenic forms, like the Spanish flu. That one is still going around every year, but hardly anyone notices because it’s become more moderate. This is how the flu virus has evolved, and if Covid continues on the same path, it will boost Yum China sales. Earlier this year, Yum had to close more than half of its restaurants due to the lockdown in China. Same-store sales fell 8% in the first quarter and profit margins fell. Yum also benefits from growing disposable income in China. When they make more money, people go out to eat.
Like Yum, China’s retail, cloud computing and media giant Alibaba is suffering from the country’s economic downturn related to the Covid-19 lockdown. “Everyone understands that China is at a different stage of the economic cycle than the rest of the world,” said Justin White, manager of T. Rowe Price All-Cap Opportunities Fund PRWAX,
BeiGene is A huge cancer treatment company. It has a big presence in China, and it’s a gateway to other big biopharma companies that want to sell therapeutics in China — like Amgen AMGN,
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned YUMC, BABA and BGNE. Brush featured CHNA, YUMC, BABA, and BGNE in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.