There are Stocks China is NOT Cracking Down On
Look for companies that have been collateral damage in the panic selling.
Four decades or so into its own capitalist history, the United States abolished its national bank and experienced the Panic of 1837, a speculative collapse that wiped out half the country’s commercial banks and ushered in seven years of depression. Against that yardstick, China is not doing too bad.
This historical sweep may bring little comfort to investors in the Didi (DIDI) IPO, or New Oriental Education & Technology Group (EDU), which regulators summarily ordered to become a non-profit. Nonetheless, a deep breath is in order after a week when ”offshore” Chinese stocks (listed in the U.S. or Hong Kong) plunged 8% and onshore “A-shares” 5% — all because Beijing called time on a few relatively tiny online tutoring companies.
Investors panicked on the premise that Chinese Communists, who have been beating up on their internet giants since last autumn, have now slipped the rails into a neo-Cultural Revolution where any capitalist concern is fair game. “‘Uninvestable’ has featured in many recent conversations with clients regarding Chinese stocks,” the redoubtable Goldman Sachs disclosed in a note.
That premise is flawed.
Granted, China’s leaders are not the clearest communicators on the planet But there is justifiable method to the madness they have unleashed on markets. New Oriental and its online “cram school” competitors had become a public nuisance, massively guilt-tripping cash-strapped families into paying up for courses solely aimed at raising test scores. President Xi Jinping himself warned as far back as March that they were creating a “social problem.”
E-commerce giant Alibaba (BABA) was bullying merchants into not selling elsewhere. Its fintech cousin, Ant Group, won investors’ hearts with an “asset light” structure that could have made 2008 look like a picnic. It placed loans by algorithm from old-school brick-and-mortar banks, without risking any of its own capital. Beijing’s last-minute cancellation of Ant’s would-be record-breaking IPO last November started the current crackdown campaign.
Xi & Co. do also drop a fair number of hints on where they might look next, and where they won’t. A lot of stocks in where-they-won’t areas sold off with the broader market.
Ren Yi, a Harvard-educated blogger with a reputation for balancing Chinese and Western viewpoints, laid out seven types of companies that might be at risk in a guest editorial this week for Caixin Global. Seven sounds like a lot, but his categories overlap: say “too big to fail” and “companies closely related to the Chinese people’s livelihood.” Yi’s list excludes a number of burgeoning sectors the leadership is likely to favor or keep its hands off: renewable energy, medical systems and equipment, high-tech manufacturing (as opposed to digital platforms), everyday consumer brands.
The biggest foreign-listed stocks are “targeted” players like Alibaba (BABA), social media/gaming champion Tencent (700. Hong Kong), and food-delivery leader Meituan (3690. Hong Kong). But three “exempt” firms crack the top 10 of the iShares MSCI China ETF (MCHI). Those would be electric carmaker Nio (NIO), down 3% last week; phone manufacturer Xiaomi (1810. Hong Kong), off 7%; and biotechnology developer Wuxi Biologics (2269. Hong Kong), which cratered by 11% . Components 10-20 in the ETF include fast-food franchisee Yum China Holdings (YUMC), which lost 5%, and Li Ning (2331. Hong Kong), the “Chinese Nike,” which slid 10%.
Who knows? A state that reins in online education may move on to fried chicken or sneakers. On the other hand, it may not. Buying opportunity anyone?
Larry Hu, Macquarie Group’s astute chief China economist, puts the regulatory assault into macro context. China’s leaders ramp up micro “reform,” he argues, when they are feeling less pressure from GDP growth targets. This is one of those junctures, with China beating the rest of the world out of the pandemic, and now being pulled along by exports to a surging USA.
It won’t last long, though. Xi will need to refocus on his pledge to double the economy’s size by 2035. And he’ll want all systems humming for an October 2022 Party Congress where he will bid for an unprecedented third term. So the market reign of terror has three to six more months to run, Hu predicts.
China has learned from past mistakes in fostering its fledgling capital markets. A series of blunders produced a 40% slide in 2015-16: Retail investors piled on leverage through “shadow banking” products; authorities tried to limit share declines, which only sowed more panic; and the central bank clumsily managed a currency devaluation. All these problems were substantially addressed, and the market doubled over the next two years. It slumped by a quarter in 2018, thanks to Donald Trump’s trade war, then nearly doubled again by February of this year.
Official Beijing showed some veiled remorse last week after the education company debacle. Securities regulators got the likes of Goldman and UBS on a conference call to assure them Chairman Mao was not really back from the grave. The statement following a mid-week Politburo meeting was a hair more dovish on the internet sector, Hu says, excluding previous tough talk against “monopolies,.”
Chinese stock market history so far tells you not to rely on it for your retirement. The MCHI ETF, with its violent ups and downs, has returned 70% over 10 years, while the S&P 500 has quadrupled. But buying the right companies at the right time can be rewarding indeed. That chance looks to be approaching for those who dare. America, by the way, has produced some pretty good investments since 1837.