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Hong Kong: What Rising Tensions Could Mean for U.S. Investors

The introduction of an extradition bill in June that was seen as further chipping away at Hong Kong’s semi-autonomy sparked demonstrations. Though that bill was eventually withdrawn, protests have continued amid calls for an independent investigation into police conduct and greater democratic rights.

“Many see it as an important front in some large moral drama between democracy and dictatorship, though it is more complicated than that,” Marc Chandler, veteran currency strategist and chief market strategist at Bannockburn Global, says.

“Like a game of rock, paper, scissors, China wins by not losing. Losing is being overt. It would antagonize the West, as Tiananmen Square did,” Chandler says. “It would strengthen independent forces in Taiwan ahead of the January elections. It would risk a split in the Chinese Communist Party, where below the surface there seems to be a criticism of President Xi [Jinping] for handling of the U.S. and Hong Kong.”

Investors have kept close watch on whether the demonstrations support inside mainland China—a move that could push Beijing to take more aggressive action and move in with troops, potentially jeopardizing China’s role on the global stage and eliciting a global response. But fund managers and strategists see little support so far in the mainland.

That is not to say there is no effect. On the ground, the protests dent Hong Kong’s role as an important financial center for China and Asia more broadly and curtail tourism, a major engine for the economy. In fact, Hong Kong has fallen into its first recession in a decade.

There are political tensions too. The escalating protests have drawn the attention of Congress, potentially threatening Hong Kong’s special status under law that treats it separately from mainland China in economic matters. The House passed a bill that the Senate still ne to approve that would reassess Hong Kong’s special status each year. The short-term hit would be manageable, but the removal of the law could lead the U.S. to restrict sales of sensitive technologies to Hong Kong-based companies. “Knowledge-intensive products from the U.S. only make up around 5% of Hong Kong’s total imports. But restricting the ability of Hong Kong-based firms to source sensitive products would remove one of Hong Kong’s distinct advantages as a business location relative to mainland China,” Capital Economics Chief Asia Economist Mark Williams writes in a note to clients.

Such a move could further accelerate the deterioration of both foreign and Chinese perceptions of Hong Kong as a place to do business. Ironically, removal of that special status could decrease the value to Beijing of preserving Hong Kong’s autonomy, Williams writes. For now, he believes that while the U.S. and China are trying to strike a trade deal, the Trump administration isn’t likely to move on the status, which could risk angering Beijing. “But if the trade talks break down, or under a new president, that calculation could change,” Williams writes.

Financial Services

As the protests escalate, questions rise about whether Hong Kong can remain a global financial capital. Financial services companies may start hedging their bets—much like companies are doing in terms of their supply chains and investing incrementally more in places such as Vietnam, Thailand, Taiwan and Mexico, Chandler says. Other investors have already noted more money leaving Hong Kong for places such as Singapore.

On the other hand,
Alibaba Group Holding’s
(ticker: BABA) decision last week to list in Hong Kong suggests it will continue to be a destination for companies—even if tensions with the U.S. rise. Alibaba had wanted to list in Hong Kong when it first pursued a stock listing but rules prohibited the move. The Hong Kong exchange changed the rules in April and Alibaba had started talking about a listing in the spring, Gavekal Research analyst Thomas Gatley writes via email. In Gatley’s view, investors in China and Hong Kong know the company better than U.S. investors, making it a better place for Alibaba to raise capital.

Tourism

The immediate impact of the conflict is being felt on retailers and online travelers whose businesses in Hong Kong have been affected. Ctrip.com International (CTRP), for example, lowered its outlook for the third quarter citing Hong Kong, which is both a popular travel destination and a transit point. In an interview with Barron’s, Chief Executive Jane Sun said the company is considering alternatives for customers, including increasing the use of Shenzhen or Shanghai as transit stops.

Walt Disney
(DIS) last week cited lower results at its Hong Kong Disneyland Resort amid a decrease in tourism from China and elsewhere in Asia and warned of more pain to come, with expectations the operating income from that park will fall by about $80 million in the first quarter.
Tiffany Co.
(TIF) also cited disruptions in its business from the protests for its revenue shortfall in fiscal second quarter and warned in late August that if the situation in Hong Kong worsened that full-year sales could end closer to the lower end of its forecast.

Fund managers such as Matthews China Fund co-manager Winnie Chwang noted in the recent Barron’s roundtable that Hong Kong-listed s are more attractive, in terms of valuation, than A-s domestically-listed Chinese stocks and U.S.-listed Chinese stocks. Indeed, in a note to clients last week,
Société Générale’s
Andrew Lapthorne said Hong Kong was in the top spot in terms of value in the Asian markets. The
is MSCI Hong Kong ETF
(EWH) fell about 2% on Monday to $24.19 though it is up 10% so far this year—significantly underperforming the is MSCI A ETF (CNYA) that is up 30% this year after a difficult 2018.

Value investors may find more opportunities as the conflict continues.

Write to Reshma Kapadia at reshma.kapadia@barrons.com