What the 'Drama' Over Taiwan Means for Chinese Stocks

By Brian Tycangco, analyst, True Wealth

On the evening of August 2, a U.S. C-40C military jet landed on the tarmac of the Songshan Airport in Taipei, the capital of Taiwan.

A few minutes after taxiing to a safe location, U.S. House Speaker Nancy Pelosi exited the plane and was greeted by a swarm of media. The following day, she met with Taiwan's President Tsai Ing-wen.

While the Biden administration stated that Speaker Pelosi's trip was her own personal decision, it was the most high-profile visit of any U.S. government official to Taiwan since former Health and Human Services Secretary Alex Azar traveled there two years ago.

That made it an official trip in the eyes of Beijing authorities, who saw Pelosi's visit as a clear shift away from the U.S. government's longstanding "One China" policy.

Beijing expressed its anger by conducting large-scale war games in the Taiwan Strait for an entire week. It sent warplanes into Taiwan's territory and lobbed missiles on both sides of the main island.

It closed the entire Taiwan Strait to commercial shipping and closed the skies above to all airline traffic.

China stopped imports of Taiwanese seafood, halted exports of sand to Taiwan, and sanctioned seven Taiwan government officials.

Tensions are still simmering today. The U.S. recently approved an arms sale to Taiwan, drawing more ire from Beijing. And if you have money invested in Chinese companies, you might be worried about what's next.

But this story is far from a nail in the coffin for Chinese stocks. Let me explain...

Taiwan is an important trading partner not only to the U.S., but also to China. It's also the world's largest supplier of semiconductors – the devices that we need to run just about anything electric (except perhaps a lightbulb).

Nearly half of the world's container ships pass through the Taiwan Strait each year... and for good reason. Everyone trades with China.

So, the potential for trouble – especially the military kind – between China and the U.S. over Taiwan is a cloud hanging over the markets in the short term.

The news coverage is creating a lot of drama that's hard for most people to ignore. It raises uncertainty about the future of the region – something investors hate to deal with.

That's going to lead to volatility. And it's something investors should be ready for as the world learns to live with the new reality of economic and diplomatic relations between the U.S. and China.

But it's unlikely that war will erupt over the Taiwan Strait. That's because trouble in this part of the world would have a big knock-on effect on both the U.S. and China...

Both economies depend greatly on semiconductors flowing out of Taiwan's multibillion-dollar foundries. And any disruption to that flow causes problems for dozens of industries down the line – everything from computers and smartphones, to cars and health care equipment.

Regardless, one thing is clear. Chinese stocks still offer tremendous value for investors over the long term.

One way we can see this is by looking at a key gauge of Chinese stocks... one that's now trading at one of the widest discounts to global stocks in history. I'm talking about the MSCI China Index.

The chart below compares this index's valuation with MSCI's global benchmark, based on the price-to-earnings (P/E) ratio for each. Take a look...

Chinese stocks typically trade at P/E ratios about 280 points lower than the global average. Now, they're trading 502 points lower. And history tells us the discount doesn't get too much bigger than this.

Importantly, every time the spread gets too wide, Chinese stocks typically experience a recovery back to the mean. It has happened several times in the past decade alone.

This doesn't mean Chinese stocks can't go lower. But it tells us the risk is skewed to the upside... which is exactly the kind of situation that ends up making a lot of money for investors who are able to ride out the "drama."

So if you're invested in China, don't let the media scare you. The worst-case scenario is unlikely to come true. And with this signal flashing, Chinese stocks should do well from here.

Good investing,

Brian Tycangco

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