Chinese stocks are selling off. Time to pick a bargain?

TL;DR

• Chinese stocks are seeing a massive sell-off, as a regulatory clampdown that started from the tech sector appears to be widening to other industries.
• While the sell-off appears to be isolated to Chinese stocks for now, it would pay to be watchful on whether there is contagion to other markets.
• As more volatility is expected in the near term until there is greater regulatory clarity, Beansprout would be patient about bargain hunting now.
• Investors can also look for interesting ideas outside of the familiar Chinese tech names, with the US tech companies facing less regulatory risk.

What happened?

When it pours, it rains! This could not have been more apt in describing the regulatory clampdown on Chinese companies in the past few months. As a result, what has started as a correction in share prices of companies directly impacted has spread to a wider correction in the Chinese stock market. The Hang Seng Index (HSI), which tracks a list of leading companies listed in Hong Kong, fell by close to 10% over the past two days, representing the steepest decline since the start of the pandemic.

As a recap, this was the series of events which led to an escalation in concerns about the regulatory risk around Chinese stocks

• November 2020 – Ant Financial’s planned US$37bn IPO in the US was halted by Chinese regulators
• May 2021 – Meituan CEO Wang Xing was warned to stay low-key after posting a classical Chinese poem which was perceived to be critical of the government
• June 2021 – Didi Chuxing was investigated by Chinese regulators two days after its IPO in New York
• July 2021 – Chinese private sector education companies come under a new set of regulations that bans the firms from making profits and raising capital from overseas markets

Read also: Why Munger might be wrong on Alibaba

What does this mean?

• Regulatory crackdown “a sign of the times”. As veteran investor Mark Mobius has said shortly after the thwarted IPO of Ant Financial, this ‘a sign of the times’ and ‘not an isolated case’. It would appear that the Chinese government is trying to limit the influence of big-tech and companies that have a dominant position in the sectors that they operate in.
• Greater risk premium attached to Chinese stocks. The regulatory uncertainty will likely cause investors to attach a larger risk premium to Chinese stocks. This would mean that to compensate for the uncertainty around what the Chinese government would do next, investors would expect a higher return to hold on to Chinese stocks. Stocks that do not meet this return requirement would then be sold off, driving downward pressure on share prices.
• Be wary of potential contagion. While the selldown has not affected stocks related to the Chinese market for now, there could be contagion to the wider market should investors decide to sell their positions in other stocks to raise cash levels. This was what happened in 2014-15, when an initial correction in Chinese stocks in mid-2014 was largely ignored by other markets until a second phase of Chinese equity sell-off led to a correction in global markets.

What would Beansprout do?

• Expect more volatility in the near term. Greater volatility is inevitable as the market will take time to digest the latest regulatory developments, and await further updates on whether there will be tougher measures to come. As such, one should not buy into the market unless one is willing to take the higher volatility!
• Long term investors should be patient about buying in. While the recent share price weakness may appear to present opportunities for bargain hunters, the tried and tested investment method of dollar cost averaging (DCA) could help to reduce the impact of volatility on your entry price.
• Look for opportunities elsewhere. Lastly, there are many investment opportunities out there, and investors can look for interesting stock ideas outside of the familiar Chinese tech names. While US tech companies like Apple and Amazon are also facing rising regulatory scrutiny, they are unlikely to be as severe as that faced by Chinese firms.