The Chinese economy is in trouble, as illustrated by its anemic second quarter gross domestic product (GDP) growth of 0.4%, followed by a surprise cut in interest rates. But the fallout will likely be positive for the U.S.

Big Trouble in Big China

China recently announced that five state owned companies, with an estimated combined market value of $2 trillion, would be delisting from the New York Stock Exchange. They are China Life Insurance, PetroChina, Sinopec, Aluminum Corporation of China, and Sinopec Shanghai Petrochemical.

There could be more, with big names such as Alibaba (NYSE: BABA) and Baidu (NSDQ: BIDU) reportedly on the SEC’s watch list.

Reasons given by China for the delisting are two-fold:

• There isn’t enough interest in the shares of the companies, and
• The administrative burden to keep the listings active is too high.

The truth is that China won’t let U.S. auditors review the books of its companies. For its part, the SEC says that these companies are failing to meet U.S. auditing standards. I don’t know what’s happening, but the whole thing looks fishy.

Moreover, it seems that the SEC is saying that the financial data provided by the Chinese companies are suspect. The China Petroleum and Chemical Corp. (NYSE: SNP), aka Sinopec, is the elephant in the room. As the chart below shows, investors are putting their money elsewhere.

This is illustrated by the On Balance Volume indicator (OBV), which collapsed recently signifying heavy selling. Note also that Accumulation Distribution Indicator (ADI) is shooting straight up. That means that the recent bounce is due to short covering. It’s never good when short sellers are very active in the shares at the same time that sellers are active, because it usually signifies volatility is about to increase.

Meanwhile, the Chinese economy is slowing so fast that the People’s Bank of China lowered interest rates on 8/15/22 after a rash of worse-than-expected economic data.

It would seem that Sinopec’s chart may be painting a picture of what’s happening to China itself.

Real Estate Bubbles at Stress Points

There are two issues that are hampering China’s growth: rolling COVID related shutdowns and a burgeoning real estate crisis. The two are related because people that don’t work don’t have enough money to make their mortgage payments.

It gets more opaque when you factor in that in China’s mortgage market it’s customary to make payments on homes that are being built even if they aren’t completed. Apparently, there are now so many homes far from completion that people have stopped making payments.

Because of the shutdowns, there is no one to build the homes, which means no one has any money to make their payments and the developers are struggling to pay their own bills as well as falling behind on debt payments to investors.

The end result is the homebuilding industry, which is built on the same debt based principles as the rest of the Chinese economy, is grinding to a halt, which signals a fragile economy. When an economy is built on debt it only takes one step along the chain to stop paying its share before the whole chain breaks.

Follow the Money to Friendly Shores

Stock investors often ignore the currency markets, because they aren’t as exciting as the stock market. But the truth is that more money changes hands in currencies in one day than what may change hands in the U.S. stock market in a couple of weeks.

The U.S. dollar is the world’s reserve currency, so what happens to the dollar matters to all investors. Generally speaking, a strong dollar is a sign of confidence in the U.S. economy, even during times, such as currently, where there are issues to be reckoned with such as rising debt and perhaps a even a recession.

But here is why the currency market is worth analyzing. Higher interest rates attract buyers to a currency, while lower interest rates do the opposite. And the Fed’s higher interest rate crusade has been a boon to the dollar. Note the general up trend for USD over the last six months.

In fact, a comparison of the U.S. dollar to the Hong Kong Dollar (HKD), a realistic proxy for the Chinese Yuan, shows that money is suddenly leaving China and moving to the U.S. Moreover, the lower China’s interest rates fall, the lower HKD will likely fall. The recent bounce in HKD is suggestive of quiet Chinese government intervention to support the currency.

The bottom line is that when money leaves a country, that economy will start to falter.

When Money Looks for Greener Pastures

Perhaps the least appreciated aspect of China’s precarious situation is the emerging trend of Friend Shoring, where companies leave unfriendly places for more favorable surroundings. And China is currently the poster child for providing reasons for businesses and individuals to look for friendly climates, a trend known as Friend Shoring.

Consider the following:

• Amazon (NSDQ: AMZN) shut down its domestic Chinese business in 2019;
• Airbnb (NSDQ: ABNB) is closing its Chinese mainland business in 2020, concentrating on offering listings to Chinese clients elsewhere in the world;
• Chinese billionaires are quietly trying to leave the country;
• The U.S. government is now encouraging Friend Shoring as supply chain issues fuel inflation; and
• Germany is encouraging its companies to diversify their operations away from China.

They are leaving quietly, but they are still leaving.

Money Will Find a Home

There are several sectors in the U.S. stock market which will likely benefit the most from Friend Shoring:

• Warehousing real estate investment trusts (REITS);
• Semiconductor companies;
• Homebuilders;
• Energy companies; and
• Engineering and construction firms.

I’ve recently highlighted the positives for the semiconductor market and how investors can capitalize on this trend. But there are plenty of U.S. tech companies that make chips in China. And the U.S. government has just put its money where its mouth is by allotting $280 billion to the sector to bring back production to the U.S.

Where I live, in the Dallas Fort-Worth metroplex, warehouses are being built on just about every available plot of commercial property that can be found. That suggests the sector is making a big bet on Friend Shoring.

The iShares U.S. Real Estate Investment Trust ETF (IYR) has been doing quite well lately as the weight from the Fed’s interest rate hikes has been lifted. REITs are very interest rate sensitive and tend to fall when the Fed raises rates.

However, recent earnings reports from several storage REITs have delivered very pleasant beats of earnings and revenues while the companies have also been raising their 2022 guidance.

Occupancy rates have been rising and there has been a pickup in acquisitions of privately held warehouse properties. There also has been an increase in land purchases by many REITS to build warehouses in expectations of increasing demand stemming from the flux in supply chain logistics.

Despite bad news on the mortgage front and signs of slowing, the homebuilders, which I have featured here many times, are in an excellent position. This is especially true of those who focus operations in the tax friendly, low regulation sunbelt states. That’s because the Friend Shoring trend will expand on the migration from blue states to red states and will continue to drive demand for housing.

And last but not least will be companies in the energy and the engineering sector, where companies that design, build and maintain the new infrastructure are found. Think liquified natural gas and nuclear. They will benefit from the increasing demand for infrastructure to support the positive effects of Friend Shoring.

China’s Troubles are Good for the U.S.

The post-COVID world continues to cause major structural changes to the global economy. China is not unexpectedly feeling the brunt of the post-pandemic environment. Many of the country’s troubles are self-inflicted and policy related.

The U.S. has largely emerged from much of the world’s COVID fear, but China’s continued lockdowns have led to an air of uncertainty for both private citizens as well as international corporations.

The net effect is that the current U.S. administration is now openly embracing and continuing the prior administration’s official policy of encouraging businesses to move operations to the U.S., aka Friend Shoring. Many companies are already transitioning and diversifying their operations away from China.

This is a positive for the U.S. dollar and likely for U.S. companies, workers, and key sectors of the the U.S. stock market.

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