Kelly Evans: Why China is turning into a liability for American companies

I have a significant disappointment from my time in university, which is that I was unable to participate in a six-week excursion to China offered by the business school. Unfortunately, due to conflicts in my schedule and other commitments, I couldn't make it happen. This happened in 2007, a time when it was becoming increasingly evident that China was poised to become the next major global powerhouse.

After several years, I finally had the chance to visit in 2012 as part of my work with CNBC. I only had the opportunity to explore Beijing, but that was enough to leave me in awe. The first thing that struck me was the immense size of the city, with city blocks that dwarfed those in Washington, D.C. There were limited options to stop and grab food or coffee during a long walk – a clear opportunity for Starbucks. However, on a more somber note, the air pollution had a dramatic impact on the absence of birds chirping or squirrels frolicking about, and the sight of dying trees added to the overall gloomy atmosphere.

However, I had assumed that by the year 2023, we would be reflecting on China's impressive progress and talking about how it had successfully resolved its numerous issues. Surprisingly, the opposite is true. China's unsuccessful recovery from the Covid pandemic has exposed its underlying economic difficulties, and this is causing concern for many American investors and businesses. China, which has been contributing to profitable returns for the past 15 years, is now becoming a risk rather than an advantage.

Maybe the most troubling title in this matter is the recent announcement that Chinese authorities are not allowed to utilize iPhones from Apple (or any other foreign gadgets) and take them to their workplaces. The stock of Apple experienced a 4% decline upon hearing this news yesterday, and it has dropped by 3% again this morning as Bloomberg is currently stating that China might enlarge the prohibition to include state-owned businesses, which are significant employers, as well as other government-controlled organizations.

Piper Sandler cautions that this is a component of a broader pattern, which coincides with ongoing disagreements between American and Chinese authorities about whether our countries are becoming less connected or reducing risks, or if nothing of the sort is happening. According to the firm, businesses with significant involvement in China have been performing below expectations since the beginning of 2022. An example of this is Starbucks, whose stock reached a peak of $125 in the middle of 2021, but now stands at only $95, experiencing a 4% decline this year.

In terms of sales, the technology industry has the greatest dependence on China, accounting for approximately 15% of their total sales. This is in contrast to the overall S&P 500, which only derives about 7.5% of its sales from China. Within the technology industry, semiconductors have the highest exposure, with over 30% of their sales coming from China. For example, shares of Micron, despite experiencing significant growth this year, are still trading more than 30% lower than their peak in January 2022. In May, China imposed a ban on Micron, prohibiting the use of its products in crucial infrastructure projects.

Additional sectors that are highly susceptible include the automotive industry, wherein Tesla's significant reliance on China has caused the overall sales percentage to exceed 20% for the Chinese market. Despite this, Tesla's shares are currently lingering at 40% lower than their peak in late 2021. Furthermore, the automotive industry is one of the key sectors that China is heavily relying on to bolster its international exports, given that BYD, a Chinese company, has emerged as the largest electric car manufacturer globally.

Moreover, various high-end retail brands and a wide range of industries spanning from medicine to power generation may encounter difficulties if their reliance on the Chinese market becomes a source of trouble rather than advantage. The pivotal question, which entails significant financial stakes, revolves around whether these brands and industries should strengthen their current presence in China and potentially allocate more resources to expand further, or reconsider their strategies.

A significant cautionary note regarding this matter is provided by the China Beige Book and analyst Derek Scissors from AEI. According to them, China's economic situation has not suddenly deteriorated, but has been off track for a minimum of 14 years and is steadily declining. To put it simply, their policy remains stagnant, their debt burden is increasing, and their demographics are starting to have negative effects. Scissors further stated that any hopes of government stimulus overcoming these challenges are bleak.

Moreover, considering the potential threat of China launching an invasion on Taiwan, as disclosed by President Xi Jinping, who has instructed his military to be prepared by 2027, it becomes increasingly unlikely for multinational corporations to invest heavily in China at this moment. It is truly astonishing to witness the complete cycle of China's transformation, its rapid ascension, and now the looming possibility of its decline, all unfolding within a relatively short span of around 16 years.