What the Hong Kong Takeover Means for Chinese Stocks

Last week, I mentioned that a return of last year's clash with China was a wildcard that could upset the markets.

Well, China has gone ahead and put my words to the test.

On May 21, China announced that it would impose a draconian new security law over Hong Kong, the largely democratic and self-governed Chinese city.

You might remember that when Hong Kong's pro-Chinese government tried to do something similar last year, the demonstrations there brought the city to a standstill. Because Hong Kong has long been a center of Asian trade and finance, the costs to China were huge, both in terms of lost money and loss of face.

From March through the end of the year, the people of Hong Kong made it clear they would not accept a takeover by China's ruling Communist Party. The Hong Kong government retreated, and the matter disappeared as the COVID-19 pandemic started spreading.

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Well, now China is trying it again. This time, they're not even pretending that Hong Kong's local government is in charge.

On Tuesday of this week, the market didn't show much reaction. The Reality Gap between the mild market reaction and the potential ramifications from an escalation in confrontation over Hong Kong has started to come into full view. The White House's announcement about a news conference on China sent the markets down 350 Dow points yesterday afternoon. And trading is muted Friday morning as traders are showing concern over how aggressive China is getting and what U.S. foreign policy and trade reactions could be. Hong Kong is just the tip of the iceberg.

And it's not about to stop. The effects on Chinese stocks could be huge...

China Is Now Openly the Neighborhood Bully

For the past two weeks or so, China has been picking fights with almost everyone it can.

On May 21, China's government announced that it was drafting a law that would make "secession, foreign interference, terrorism and subversion against" China's Communist government illegal in Hong Kong.

This is the first time China's central government has tried to impose something like this on Hong Kong. In the past, they at least pretended to respect Hong Kong's "special status" as an autonomous part of China.

The Wall Street Journal called this move "the nuclear option."

Three days earlier, China had made sure one of its proxies was re-elected in Hong Kong by removing everyone who would vote against him from the city's legislature.

The people behind last year's successful anti-China protests in Hong Kong are already gathering supporters. But with Hong Kong still under COVID-19 restrictions and many people fearing the return of the virus, it's much harder to convince the people of Hong Kong to get out into the streets.

As serious and aggressive as this takeover of Hong Kong is, it's not the only fight China is picking right now.

In the past few weeks China's President, Xi Jinping, sent his Coast Guard to ram into and sink a Vietnamese fishing boat, as well as surround a Malaysian offshore oil rig. Both events happened in waters China considers to be theirs, despite the waters being closer to other countries and an international court ruling that China has no claim.

In the Himalayas, President Xi has sent military reinforcements to the disputed border with India. Chinese soldiers there had gotten into fights with their Indian counterparts, leaving people on both sides bloodied and hurt.

Meanwhile, China's allies in Nepal's government have suddenly accused India of stealing territory, also in the Himalayas.

Earlier in May, the prime minister of India's other big neighbor, Pakistan, declared that India is thinking of launching a terrorist attack on itself and blaming Pakistan.

Mind you, Pakistan is a Chinese ally with a long history of supporting or at least not stopping Pakistani terrorists that plan attacks against India.

If anything, this announcement seems more of a threat of an impending strike against India than anything else.

Unfortunately, the ability of India, Vietnam, Malaysia, and other countries to resist China's aggression right now is small. They're all focused on defeating the COVID-19 pandemic that first started in China.

So is the rest of the world.

President Trump has been blaming China more and more over the country's early cover up of the COVID-19 pandemic, and has been imposing more and more sanctions on Chinese tech firms. The White House is also seemingly in support of a Senate bill that would require all foreign stocks listed on American stock exchanges to be audited and show that they are not under the control of a foreign government.

China itself has said that this would drive many Chinese companies away from U.S markets. It's safe to assume this is because any audit would show that many of them work very closely with the Chinese government.

In response, China has ratcheted up its rhetoric and is taking a tougher stance. It has threatened to sanction American tech firms working in China and said it would "take countermeasures" if the U.S. tried to interfere with Hong Kong.

The one bright spot is that Chinese officials have said they continue to abide by the Phase One trade deal that President Trump signed with China in January.

Even this long list of recent Chinese aggression isn't complete.

For example, China just started a trade dispute with Australia, and for the first time since 2013 removed the word "peaceful" from its annual report on how to take over Taiwan, which China considers a breakaway province.

Mind you, Taiwan is a close American ally. Any non-peaceful attempt to take Taiwan would probably lead to war with the U.S.

All in all, it's clear that China's President Xi Jinping has come out of the country's COVID-19 crisis more belligerent to the outside world.

Here's why - and why he's not about to stop...

The West Is All Bark, No Bite - and China has Little Left to Lose

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It's become clear to President Xi that the West's protests don't mean much. For years, China has been doing horrific things to its Muslim minority in the western Xinjiang region. For decades, China has been chipping away at the freedoms of Hong Kong, and claimed more and more islands in the South China Sea.

At every step, we've issued protests and warnings with little real effect.

Last year, China was hit by President Trump's trade war. But as it dragged on, it started to look like China was gaining leverage. The trade war was hurting rural America just as President Trump's reelection campaign was beginning.

In early January, that trade war ended with the Phase One trade deal. Soon after, the COVID-19 pandemic exploded worldwide, in no small part because of China's coverup.

Europe and America both have recently started criticizing China's actions in the early days of the pandemic. But both have largely stopped there. The only real action against China has been the fight over Huawei, China's smartphone and telecom giant.

The White House has made it illegal for companies to supply Huawei with microchips made using U.S. technology, and the UK is considering banning Huawei from working on the British 5G network.

Other than that, China's gotten off scot-free - even though its coverup has been a key part that led to a catastrophic pandemic that's cost over 350,000 lives and shut down most of the planet's economy.

It seems that President Xi is using the outfall of the pandemic as cover for the next set of power moves.

And don't forget the position China is in right now. With Europe and America only now reopening their economies, China's export industry has been on ice. President Xi now has a pretty good idea of what it would be like if the West stopped trade with China.

But the pressures from inside China are mounting. Some regions of the country are under a new COVID-19 lockdown, and the government's catastrophic mismanagement of the early days of the pandemic has been extremely unpopular.

Creating an external enemy is a good way to deflect that criticism before it turns into something more dangerous. Especially when some of those external enemies look like they're doing an even worse job of handling the pandemic than China's government did.

So whether President Xi thinks he can handle a Western trade embargo, or whether he thinks the West would never stop trading with China because we haven't done it yet despite all that he's done, Xi needs to show his people that China is powerful and strong.

And he has reason to think that the U.S. and Europe will let him get away with it.

Meanwhile, the governments of Europe and America could also do with a distraction from the missteps they've made during this pandemic.

China fits the bill perfectly, as the pandemic came from there.

In other words, when China's Foreign Minister recently said that China and the U.S. were "on the brink of a new Cold War," he was absolutely right. And it's clear that China's government is the lead instigator.

All this means that last year's market volatility surrounding the U.S.-China trade spat is only going to get worse this year. Trade, tariffs, and sanctions are going to be an issue again, this time more over tech than farming.

But it won't stop at trade. White House economic advisor Larry Kudlow recently said that President Trump is so "miffed" at China that he doesn't care about a trade deal as much as he used to.

In the short-term, this is going to hurt Chinese stocks. China's ecommerce giant Alibaba Group Holding Ltd. (NYSE: BABA), for example, dropped 10% over Thursday and Friday last week.

Expect more as the saber rattling continues.

But as you'll remember from last year, these things come in waves. Neither side wants a real war, so after a week or two of aggressive speeches, they'll both start getting more friendly again. And Chinese stocks will bounce back up - until the saber rattling restarts.

So in the short term, but strong Chinese stocks on dips. BABA can stay on your list but I like JD.com (NASDAQ: JD) even more. In the longer term, keep a tight leash on Chinese stocks in your "nest egg" portfolio.

I'll be keeping a close eye on the news here. Because if cooler heads don't prevail, we could see things get very serious - and that volatility could lead to some big profit opportunities, especially for some prudent longer term put buying...

The post The Hong Kong Takeover and What It Means for Your Portfolio appeared first on Straight-Up Profits.

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About the Author

D.R. Barton, Jr., Technical Trading Specialist for Money Map Press, is a world-renowned authority on technical trading with 25 years of experience. He spent the first part of his career as a chemical engineer with DuPont. During this time, he researched and developed the trading secrets that led to his first successful research service. Thanks to the wealth he was able to create for himself and his followers, D.R. retired early to pursue his passion for investing and showing fellow investors how to build toward financial freedom.

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