Balloon Controversy Threatens to Deepen China Stock Losses

(Bloomberg) — Chinese stocks extended losses as tension with the US over a suspected spy balloon triggered fears of economic retaliation by the Biden administration.

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The Hang Seng China Enterprises Index, which tracks Chinese stocks trading in Hong Kong, slumped as much as 3.3% Monday, taking its decline from a January peak to nearly 8%. The CSI 300 benchmark of mainland shares was down 1.7% as of mid-day trading break, headed for its worst day since the end of October.

The developments are a reminder of the geopolitical risks of investing in China, pouring cold water over bullish sentiment that’s been prevalent since Beijing’s Covid Zero exit. Weakness was already showing in Chinese stocks as the reopening rally cooled last week. The nation’s clash with the US, which led to the postponement of a visit by Secretary of State Antony Blinken, may accelerate the market’s downshift.

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“Both sides will likely impose more export bans on technology in different industries,” Iris Pang, chief economist for Greater China at ING Groep NV, wrote in a note. “This is a new threat to supply chain disruption, although the risk of logistical disruption from Covid restrictions has now disappeared.”

President Joe Biden is under pressure to take a strong stance against any perception of Chinese infringement. That may mean the episode is raised in his State of the Union speech Tuesday. Blinken could go also ahead with the visit to China, but with a much tougher message than planned.

Investors are now keeping a keen eye on how the bilateral tension unfolds to assess whether Chinese stocks can resume their uptrend. The CSI 300 slipped on the verge of a bull market last week, suggesting a mix of profit taking and cautious outlook after hefty gains. Meanwhile, the Hang Seng China gauge is nearing a technical correction after posting trough-to-peak gains of over 57%.

In the currency market, the yuan reversed an initial loss on Monday after the government set a stronger-than-expected reference rate for the currency.

Foreigners were net sellers of Chinese stocks for the second session, offloading more than 4 billion yuan ($589 million) worth of shares Monday morning. That comes after overseas funds scooped up a record amount of mainland shares in January.

“The episode should be a big surprise to investors given market’s previous expectation was that Sino-US relationship could improve after the now called-off Blinken visit,” said Willer Chen, senior research analyst Forsyth Barr Asia.

–With assistance from Chester Yung, Rebecca Choong Wilkins and Charlotte Yang.

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