US curbs on investing in China look narrower than feared

The White House has announced a ban on select investments in China, including in quantum computing, advanced chips, and artificial intelligence. The Biden administration said Chinese advances in these sectors presented “significant national security risks,” claiming such technologies could be used to develop advanced weapons and crack codes used by intelligence agencies to protect data.

The latest move underlines our view that US-China tensions will remain elevated. A regime of increasing restrictions on technology transfer and capital flows between the two nations is likely to take hold and become a persistent issue for investors. This risk was underlined by a statement from the Chinese government that it was “gravely concerned” by the news and that it reserved the right to take measures in response.

But we do not expect the US administration's new measures to represent a significant drag on markets:

• The curbs were long in the pipeline and were widely anticipated by investors. The Executive Order by the Biden administration follows nearly two years of negotiations. More broadly, we believe that President Biden’s new executive order represents another step in an expected longer-term process by which the administration will add rules to monitor US investments in nations with whom the US has a more contentious relationship. As a result, we don’t believe investors will be taken off guard. The prospect of outbound restrictions likely already contributed to a reduction in cross-border US investments, with the aggregate value of US investment in China falling by roughly 76% in 2022 from a year earlier, according to S&P.
• The restrictions look set to be relatively narrow both in terms of industries affected and the type of investment. The administration explicitly stated that the program, once implemented, will not impede all investments in countries of concern or impose sector-wide restrictions on the activities of US persons. The production of raw materials, intellectual property licensing, and routine banking services are not expected to be restricted by the new rules. Mergers and acquisitions, private equity investments, and venture capital are likely to be covered by the new program. A carve-out for publicly traded securities and certain types of investment vehicles, such as exchange-traded funds, is expected. Finally, the order won't go into effect until next year, won't be retroactive, and will exclude sectors such as biotechnology.
• Frictions between the US and China, though still elevated, appear to be finding a floor as high-level meetings and dialogue resume between the two sides. Despite Chinese government statements of concern, the narrow scope also means China is less likely to pursue a direct and significant tit-for-tat response, in our view, such as restricting exports of rare earth metals or critical minerals. More broadly, there have recently been signs of a stabilization of relations between the two countries. President Biden and President Xi Jinping agreed at the G20 in Bali in November to try to ensure that rivalry did not develop into conflict.

So, the language of the announcement should ease fears of broader and stricter curbs, which have been a key overhang on Chinese equities in recent months. With geopolitical risks likely on the back burner for now, we think Chinese equities are in a better position to benefit from potential policy support over the near term. We continue to favor a barbell approach to Chinese equities that balances recovery beneficiaries (internet, consumer, materials, industrials) with defensive sectors.