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Is the China Stock Market “Uninvestable”?

China

Written by:

Yao Nan

Once again a major panic sell-down was initiated by investors amid broader crackdowns by the Chinese government.

I understand that many who are invested in the Chinese stocks are worried about the recent crackdown and wonder if the China market is still a good opportunity to be investing in.

Here’s are some of my thoughts.

Is it true that the Chinese government can kill any industry they want? For example, the recent clampdown of the Chinese Edutech companies

It was unfortunate for investors who have positions in private education companies. Stocks such as TAL Education which tanked more than 70% in just a single day when the news that Edutech companies will be forced to go “non-profit” was out.

Why I didn’t have positions in Chinese Edutech?

Back in 2018, a couple of Chinese Edutech stocks were hit by the short-sellers. An example was Muddy Waters’ labelling of TAL Education as “fake finance”.

Since then, I’ve been quite sceptical of Edutech companies in China and was never into that industry.

Source: Forbes

Investors speculation and fear overrode fundamentals

Fast forward today, the current episode has intensified discussions on social media about how China is trying to deter companies from listing overseas.

Some are pushing the narrative that the Chinese government can control everything and do whatever they want to listed companies, which resulted in even more fear in the market. Fear brought the entire Hang Seng Index down by 5% on 28 Jul 2021.

Many are “selling now ask later”.  My take is that the Chinese government would eventually want their big domestic players to be able to expand globally. However, this market will always be overwhelmed with greed and fear.

On an objective note, the recent clampdown of Edutech companies might be due to the census data and to encourage citizens to have more kids by driving down the cost of raising a child. This move isn’t about “killing the foreign investors”. If they wanted to, there are many better ways to do so.

CNA has also reported that:

“This is more to calm the market to isolate the education industry and not to over-interpret it,”

– one of the people, who has knowledge of the regulatory meeting chaired by CSRC vice chairman Fang Xinghai. (CNA)

Curbing the seemingly overpriced Edutech industry to encourage larger family size

In developed nations like Singapore research have found that the majority of the students were enrolled in private tuition.

Comparatively, China is still an emerging economy where the GDP per capita is very much lower yet the education sector has grown into a US$260 billion industry. Many listed companies are raking huge profits from parents.

Curbing the impact of games on their future generations

Just today (at this point of writing) Chinese state media branded online gaming as “spiritual opium” and called for more curbs on the industry that resulted in Chinese gaming stocks tumbling. If there is any crackdown, likely it would be more targeted towards cutting down students gaming hours.

However, my guess is that I don’t think gaming will be gone completely. There are also adults playing games, not just students.

According to Statista, adults age 21 and above make up 91% of mobile gamers worldwide (as of December 2018):

Source: Statista

Let’s take a look at Tencent. Although gaming is currently the largest contributor of their revenue, Tencent has other revenue-generating segments such as social networks, online advertising, fintech and investments.  etc despite gaming being the largest contributor of the revenue.

Source: Tencent Investors Relations

Tencent will not rest on its laurels, but would probably work with the authorities to improve its services.

Just recently, Tencent has also rolled out a facial recognition “midnight patrol” function to curb kids masquerading as adults for underage gamers. This new feature would be rolled out on 60 mobile games including the popular “Honor of Kings” which had more than 100 million daily users.

In addition, Chinese gaming companies are not just eyeing on the domestic market, they want to grow worldwide as well.

Tencent is the largest gaming company in the world in terms of revenue have been buying up companies worldwide. Tech investor Rodolfo Rosini mentioned on Twitter that: “Tencent keeps buying the #1 game in every niche in North America and Europe.”

Source: CNBC

Although the Chinese government is known to work with an iron fist, they are not incentivised to kill any industry nor foreign investors. In fact, they would stand to gain more if their private companies do well.

That said, as a one-party system, they have to put the well-being of their people first.

Does China’s “One-Party System” make it a bad market to invest it?

There are many headlines of funds dumping China Stocks. But why is it so and is there a disadvantage to investing in a  “One-Party System” than a democratic one?

A “one-party system” has its unique advantages. For example, regulations could be pass very quickly, unlike in democratic countries where proposed regulations have to undergo many rounds of debates before they can be finalised.

And the results speak for themselves. China is able to grow at a fast rate, reporting an average GDP growth rate of more than 9% in the past 3 decades.

That said, the major downside is that it lacks checks and balances.

How China had managed the COVID situation show what they are capable of. If the way they run things does not work, we wouldn’t see such news:

Source: BBC
Source: South China Morning Post
Source: CNBC

I had previously touched on the various innovation initiates of China such as being the first country in developing the digital yuan.

As an investor, it is not for me to judge if a country’s policies are right or wrong. I’m not an expert in that area but we could observe from the results of China’s various achievements in multiple areas.

However, the reason why the Chinese stock market is not as buoyant as other markets is due to its liquidity. I have covered 4 reasons here previously.

Let’s talk about Malaysia

Some friends have told me that certain country market is “uninvestable” such as Malaysia (disclaimer: just his personal views) especially after events like the 1MDB case. But unlike him, I find that no matter which market you are in, there are always GEMS you can find in the market itself.

For example, if you have invested RM$1200 into Public Bank (Malaysia) from the year 1967, it would be worth RM$2,760,000 (capital gains, bonus issue etc) in 2015 and your investment would come with RM$1,080,000 worth of dividends.

Disclosure: I do hold some Malaysian stock and even an Israeli company listed in NASDAQ.

Will big Chinese tech companies eventually be broken up or taken over by government and can the regulations get worse?

I believe that the objectives of China are about ensuring fair play rather than killing the big tech companies. They would want their domestic players to be able to succeed in the global arena instead of focusing on monopolising within the domestic market.

With the stricter regulation, these companies are pushed to innovate further and provide better services to win their market share instead (i.e. having organic growth).

Recently we’ve seen headlines of Temasek reporting their net portfolio value, and they remain bullish on the growth prospects of China and the technology opportunities.

Source: CNBC’s “Singapore’s state investor Temasek reports record portfolio value of $283 billion”

If the government allowed such moves, these companies might become too comfortable focusing on monopolising, rather than spending efforts on R&D and innovation and could end up losing globally.

Recently, the Chinese state media mentioned that China is planning to advance international cooperation in the digital economy and technology space. Generally, these advancements require big tech companies to expand worldwide. If they were to kill their own big tech, there wouldn’t be capable companies left that can expand overseas to “为国争光”, i.e. become the pride of one’s country.

Should we be worried that the Chinese government is out to revamp the entire variable interest entity structure for US listed Chinese ADR stocks?

Source: CNBC

China’s securities regulator has recently updated brokerages that they will continue to allow Chinese companies to go public in the U.S. as long as they meet listing requirements, stating:

“The cross-border stock listings can also occur using the variable interest entity structure, the source said, citing the regulator. It refers to a legal structure which allows international investors to access shares of Chinese companies in the U.S.”

CNBC

Recently, China has also engaged US SEC on overseas IPOs where SEC has requested to seek additional disclosures from Chinese companies prior to selling stocks. However, my personal take is still that if I’m into China stocks, I will consider those listed on HKEX or Shanghai / Shenzhen Exchange.

This isn’t a novel event. In fact, I recall something similar and much worst case that happened previously between Singapore and Malaysia. If you have been in the market for 30-40 years, you would have recalled this news in the year 1989 when Singapore and Malaysia severed stock market links.

Fast forward, our blue chips stocks are still around today. However, this is a story for another day.

Conclusion

Like any developing economy, it has to go through many ups and downs which I categorized as “growing pains”. I view China as a big ship that is trying to steer in the right direction. It may take some time to get it right but eventually, it’s still moving forward and to a better position.

Recalling the subprime mortgage crisis back in 2008/09 whereby all hell broke loose when the government allowed big banks to fail or like the recent Edutech clampdown, which surprised most investors and wreck confidence. Without these eventful situations, the stock market will never get cheap and you might not otherwise get such opportunities to buy the stocks at such a discount.

In general, it takes time and patience when it comes to investing in the China market. This isn’t about making quick returns; it takes faith and conviction for the market that you believe in and is probably not suitable for those who can’t stomach volatility.

A final anecdote

Last year, we saw news that Singapore banks were required to cap their dividends. Is this considered “national service”? Again, without eventful news like this, DBS won’t be trading at around $18+ last year.  

And recently we all know that:

Who knows if China is going to throw another curveball? While I can’t predict how long the “crackdown” will last, I view this “crackdown” as a period of “cleansing” and setting things right for tech to flourish in the long term.

Having a one-party system might mean they could implement policies faster and more aggressively and they might be “more pain” ahead. However, just like constructing tall buildings, the foundation has to be built stable and deep.

These “foundations” are akin to regulations on data sharing, cybersecurity, sound eco-system, consumer protections and also in building an innovative culture rather than to focus on merely growing from the big domestic market via “monopolistic strategies”.

I’ll end off with a recent write up by Ray Dalio (founder of Bridgewater Associates, the world’s largest hedge fund) on “Understanding China’s Recent Moves in Its Capital Markets”. He wrote about the 2015-16 currency meltdown which investors perceived as a piece of evidence that China is moving away from developing capital markets. 2015-2016 also coincides with the period where I’ve started to invest in China stocks. Since then, many young Chinese companies have grown into market leaders.

As small investors we do not have a crystal ball and who knows what the Chinese government will crackdown on in the coming weeks. That said, this will be a short but painful period as we ride through the uncertainty. I believe that the China market will continue to grow and Chinese companies will rise up in the long run.

If you hold similar belief, do join Alvin at his next live webinar where he’ll share

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Disclaimer: The article is purely my opinion based on my research/study. It does not constitute any form of financial, investment or advice. Just sharing my own experience as I have put my own money into the stock market for over 17 years. I am not a Chartered Financial Analyst (CFA) Charterholder and I do not have any finance-related qualifications

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