Concerned about the growing power of its largest technology companies, China authorities recently started issuing a flood of antitrust and antimonopoly laws and they show no signs of slowing. The activity has devastated China stocks.
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The regulatory tightening started with a trickle late last year, but intensified in terms of its duration, intensity and scope. Moreover, China leaders continue to offer no sign of what’s to come.
“It feels like an episode from the Twilight Zone, where no one knows what Big Brother from Beijing is going to do at any given moment,” Wedbush Securities analyst Dan Ives told Investor’s Business Daily.
Regulations targeting specific sectors such as e-commerce platforms, financial technology, social media and online education have gouged the market caps of many China stocks, in some cases cutting them by more than half. This includes China stocks such as Alibaba (BABA), Tencent Holdings (TCEHY), Baidu (BIDU) and JD.com (JD).
“It feels like every day there is another regulatory shot across the bow from Beijing which is adding pronounced risks to Chinese tech stocks across the board,” Ives said.
The collapse in China technology stocks comes as the liquidity crisis at Evergrande, the world’s most indebted Chinese property developer, has shaken markets worldwide. Evergrande has obligations of more than $300 billion to creditors and other businesses. As it struggled to make an $83 million payment to foreign investors, that raised concerns about the broader health of China’s real estate sector and triggered a wider sell-off.
Actions Hitting China Stocks
The wave of antitrust and regulatory actions by China initially emerged in November. That was when China halted the planned initial public offering of Ant Group, a financial technology giant spun off from Alibaba.
Ant Group hoped to raise $34 billion in what would have been one the largest IPOs in history. But Ant became a competitive challenge to China’s state-run banking system.
Ant has been forced to scale back business operations and dismantle arrangements that have given it a big advantage over its rivals as well as the country’s banks.
Then in February China released antimonopoly rules targeting the business models of Alibaba, Tencent and other internet giants among China stocks. It prevented them from forcing consumers not to interact on other platforms, and from providing differentiated prices to customers.
It also counts as the first time the market regulator attempted to define what constitutes anti-competition practices among internet companies under the law.
In March, e-commerce platform Pinduoduo (PDD), ride-hailing firm Didi Global (DIDI) and online delivery company Meituan were fined for slashing prices to edge out competitors, a practice known as price dumping.
Meanwhile, Alibaba paid a $2.8 billion fine in April. The so-called Amazon (AMZN) of China was charged with forcing online merchants to open stores or take part in promotions.
Gaming Stocks Also Targeted
It didn’t stop there. China then went after online gaming companies in August. That hit Tencent, NetEase (NTES) and Bilibili (BILI).
China also issued other rules against what it saw as unfair competition. Large fines were imposed on Alibaba, JD.com, Vipshop Holdings (VIPS) and others for alleged monopolistic behavior, and other practices.
The result?
The Hang Seng Internet & Information Technology Index, containing internet and information technology stocks listed in Hong Kong, is down 42% from its peak in February. Another, the Hang Seng Tech Index, plunged 44% in the same time frame. It represents the 30 largest technology companies listed in Hong Kong.
In addition, the MSCI China Index, which tracks large- and midcap equities among China stocks, sank 30%.
Among individual stocks, Alibaba dropped 53% from its record high set in October. Vipshop, another large China e-commerce company, collapsed 74%. Baidu slumped 56%, Tencent lost 39%, and JD is down 30%.
A Surplus Of Market Uncertainty
“Markets hate uncertainty, and the implementation of these internet regulations has created a surplus of that,” said Brendan Ahearn, chief investment officer at KraneShares, a China-focused provider of exchange traded funds. “Many institutional investors are staying on the sidelines until there is clarity on the regulatory end game.”
But as the government crush has created massive uncertainty for the future of China stocks, U.S. stocks could benefit.
“The current regulatory crackdown from Beijing is not going to let up, ultimately causing more of a rotation for investors from the China tech sector to the U.S. tech sector over the coming year in our opinion,” Ives said. He favors Apple (AAPL), Microsoft (MSFT) and DocuSign (DOCU).
“We continue to expect a massive rotation from the China tech sector into (U.S.) tech stocks heading into year-end,” he said.
As to when China stocks are likely to turn favorable again, it’s unclear. Some analysts remain optimistic, others pessimistic. Right now though, buying China stocks would be like catching a falling knife.
Caution Is The Key Watchword For China Stocks
George Magnus, an associate at Oxford University’s China Center, recently said the introduction of rules at random moments confounds most investors.
“I’m not saying that investors cannot make money in Chinese markets. But they’re much riskier than what we thought six months ago,” Magnus said in an August interview with Goldman Sachs. “So, caution should be the key watchword, and investors should fully understand what they are buying, and (that) those prices are discounted to reflect this risk.”
Investors in China stocks remain on guard for what regulators may target next as the government tightens.
China recently announced plans to overhaul its $100 billion for-profit education industry, saying those companies have to become nonprofit entities. This also included banning tutoring companies from making a profit and teaching on nights and weekends.
That sent shares of New Oriental Education (EDU), the country’s largest after-school tutoring firm, into free fall. TAL Education (TAL) also got tackled.
App-based ride-hailing and food delivery service companies also face government pressure to improve conditions for their low-wage workers.
“I think this is the new normal for China,” said Andy Rothman, investment strategist at Matthews Asia. “They’re seeing what’s happening to other parts of the world that has led to social unrest and are trying to head that off.”
Matthews Asia specializes in investing in Asia’s equity and fixed income markets. It works for institutions, intermediaries and retail investors worldwide, with $31 billion in assets.
U.S. Congress Has Similar Concerns
Rothman says the same debates taking place in Washington, London and other capitals around the world drive regulatory changes in China. The Chinese government has similar concerns about competition, consumer rights, antimonopoly practices, data protection and inequality of opportunity.
After years of admonishment from lawmakers over how they run their business, Big Tech executives at Amazon, Apple, Facebook and Google now face a tech backlash from Washington in ways unlike ever before. Congress has even threatened to break them up.
“These are all issues that we’ve been debating in the U.S. a long time,” Rothman said. Analysts say the key difference is that China is taking a stronger and more heavy-handed approach to regulation and enforcement. That’s hurt investor sentiment and China stocks.
What is not entirely clear to experts is the intentions of Chinese President Xi Jinping.
One theory is Xi wants to emphasize “common prosperity” in remaking the world’s second-biggest economy. The goal is to promote more sustainable and equitable growth and address the country’s widening wealth gap.
But many observers see a clash between Xi’s vision of the government’s economic powers and the private sector. Businesses might have grown too powerful and prosperous for the president’s liking.
China Stocks: Communist Party Asserting Supremacy
Some argue the Chinese government seeks more power and control. It’s the Chinese state reasserting its dominance over the private sector.
Magnus, in his Goldman Sachs interview, argued that China wants to assert the supremacy of the Communist Party. As such, investors in China stocks should tread cautiously.
“For any investor looking at an index that’s dropped 40%-50% in six months, a bell inevitably goes off that says: Value!” he said.
“But in this case investors should be careful, because China is not your run-of-the-mill investment universe, given the political intervention and extremely limited company transparency,” Magnus went on to say. “As we’ve seen, the intervention of rules at random moments is difficult for most investors to navigate.”
Others view the regulatory actions by Xi as a desire to achieve sustainable and socially responsible growth. Part of the plan is to safeguard consumer data and national security. It’s also to protect gig economy workers and level the playing field for lower-income households.
But Xi’s crackdown on private enterprise, and the fear of further measures, could chill economic growth, which has already weakened in recent months amid various Covid shutdowns.
More Scrutiny Of IPOs
The changes have also brought uncertainty to the IPO market.
For instance, in late June China’s largest ride-hailing network, Didi, raised $4.4 billion with one of the most anticipated initial public offerings this year. It listed on the New York Stock Exchange with a valuation of $67 billion. But the party didn’t last long.
Two days after Didi’s IPO, the Cyberspace Administration of China placed the company under investigation for flouting data security protocols. Since then, Didi stock has been cut in half.
Among other things, Chinese authorities want to control the amount of capital raised through the U.S. markets. They would prefer to see that brought back to the Chinese mainland or to Hong Kong markets.
In addition, the Securities and Exchange Commission recently announced that Chinese companies seeking to conduct an IPO in the U.S. will need to provide greater disclosure.
China stocks focusing on tech raised a total $46 billion on public markets since January 2020. That includes both primary and secondary listings.
Please follow Brian Deagon on Twitter at @IBD_BDeagon for more on tech stocks, analysis and financial markets.
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