Investing In China: Have We Seen The Bottom For Chinese Stocks?

There is never a dull moment in the stock market. While investors were focused on the much-anticipated Fed rate increase, it was Chinese stocks that stole the headlines with sharp falls and rises in the past month.

To recap, a combination of concerns about whether China could see economic sanctions from its close relationship with Russia, continued regulatory risks, as well a spike in local Covid-19 cases led to a sharp plunge in the share prices of China stocks in early March.

Due to the numerous risks faced, global investment bank JP Morgan had called some Chinese internet names “uninvestable”. In our article “What should we do with Chinese stocks on fire-sale”, Beansprout suggested that we would be looking out for a few indicators to determine the direction of the Chinese market. These include (1) no spillover of sanction risks to China, (2) stabilisation in the Covid-19 situation, and (3) government policy support.

These concerns were partly eased after Chinese officials denied claims that Russia had sought its military assistance in Ukraine and suggested that the tech crackdown was near an end.

An index of Chinese technology stocks, represented by the KraneShares CSI China Internet ETF (KWEB), has recovered more than 40% from its lows in mid-March. The question on everyone’s mind is whether the bounce we subsequently saw is a dead-cat bounce, or have we truly seen the bottom in Chinese stocks?

Growing Regulatory Support

When it comes to Chinese tech stocks, regulatory risk is always going to be at the back of every investor’s mind. On this issue, investors cheered the pledge by Vice Premier Liu He to stabilise capital markets and end crackdowns on private enterprises.

Following the bounce in Chinese shares, the market is now awaiting to see how this talk is going to be translated to action. For now, it seems like the market is not entirely convinced as news of further regulatory clampdown continues to trickle in. For example, there are media reports that the Chinese government is preparing new regulations on the live-streaming industry including a daily cap on tipping. However, these measures could be seen as a narrow set of measures that are targeted at a specific sector, rather than a reversal of support.

More importantly, China is reportedly removing a major hurdle to allow the US full access to audits of most Chinese companies listed in the US. Recently, Chinese companies such as iQiyi, Futu and Baidu were added to a list of companies liable under the audit oversight law, leading to a sharp fall in their share prices. The move to allow access to audits could help to lower the risks of these companies being forced to delist if they are not able to comply with audit inspection rules.

Covid-19 Situation Remains Uncertain

To add to the woes, China is facing its worst Covid-19 outbreak since April 2020, leading to further concerns about how this will affect domestic consumption and global supply chains.

China has always stood out from the rest of the world due to its zero-covid policy. While the rest of the world has seen a surge in Covid-19 cases with the Omicron variant earlier, China has been able to keep cases under control with its strict testing and lockdown regime.

However, this strategy has been put into question with the spike in cases in recent weeks. On 3^rd April, China reported more than 13,000 locally transmitted asymptomatic and symptomatic cases, the highest national case count since the start of the pandemic in February 2020.

This has led Shanghai to enter what is seen as essentially a lockdown as its 26 million residents are asked to undergo repeated testing. As China’s financial capital and most populous city, such lockdowns have led to concerns about how supply chains and businesses could be impacted.

Tesla had to halt production at its Shanghai factory from 28 March and had hoped to halt production for only four days. However, the extension of tight movement restrictions has led to further disruption to its production plans.

Closer to home, Singapore-listed Venture Corporation also temporarily halted its operations in Shanghai for a short period due to the lockdown in Shanghai.

The ability to stabilise the pandemic situation and limit its impact on business operations will be key to watch. Here, we will be looking out for whether the virus is contained within selected cities, and whether the Chinese government is willing to ease measures even if cases were to remain high.

Back To Fundamentals

The sharp bounce we have seen following the announcement of Chinese support for the stock market tells us that we should not panic during a sell-down. More importantly, we need to assess the fundamentals of a company when deciding whether to invest in a stock.

For example, in the area of e-commerce, growth has been slowing down as online retail sales only grew by 1.4% YoY in January. Structurally, the percentage of China’s retail sales that were done online appears to have plateaued. The proportion of online retail sales fell to just 24.5% in 2021 from 24.9% in 2020, mirroring a re-opening reversal in many other countries.

This has affected the prospects of Alibaba, which needs to find new growth opportunities in the face of slowing domestic growth and rising competition from Douyin, China’s TikTok. We evaluate some of these drivers in our recent article “Is the worst over for Alibaba?”

As the regulatory outlook improves, it would seem like some companies may benefit more than others. While the correction could present opportunities for investors who can afford to take a longer-term view, it is still fundamentals that determine a stock’s prospects at the end of the day.

Read Also: The Ukraine Crisis: Why This Could Be Time To Look At Singapore REITs

Gerald Wong, CFA, is the Founder and CEO of Beansprout, Singapore’s next-generation investment advisory platform licensed by the MAS. He has more than 13 years of experience in investment advisory, and was previously the Head of Singapore Securities Research at Credit Suisse. Gerald believes in empowering investors to make smarter decisions by providing them with customized insights, and has been actively involved in raising awareness of the Singapore equity market. He runs a Beansprout Telegram Chat Group where he shares his market insights with passionate investors.