Chinese stock crackdown- Stop the fear-mongering

Since the beginning of July, there has been an uproar in the investing community & Wall Street, over news of Chinese regulations. In early July, Chinese authorities ordered app stores to remove DiDi from their service, while also announcing a cybersecurity review of the company due to concerns of data security. China had previously given a warning to DiDi prior to their IPO launch on June 30 to allow them to investigate these concerns, but DiDi pushed forth to launch the IPO. As a result, Chinese authorities took action. Since then, China has launched cybersecurity reviews on three more Chinese companies listed in the US. Around the 23^rd of July, China made the move to restrict for-profit education companies from making money through foreign stock listings, while foreign capital cannot invest. Finally, China’s antitrust administrator ordered Tencent Music Entertainment to give its exclusive music licensing rights for online music. These three incidents that have occurred over the month of July have sent shockwaves across the investing community, resulting in numerous consequences that have played out over these past few weeks.

One of the biggest consequences to China’s crackdown has been both the plummeting of individual stocks as well as related indexes. The MSCI Chinese Index has dropped over 20% since February, after gaining 50% over the previous year. In terms of individual stocks, DiDi has been hit significantly as it has been down by over 35% from its high on June 30^th of $15.53 to $9.84 as of August 3^rd. Since the 21^st of July, TAL Education has been down by 70% while New Oriental Education has also fallen by 70% from 51 HKD to around 16 HKD. Similar educations stocks like Gaoutu Tech and 17 Education & Technology have fallen by around 70% and 55% respectively, by looking at its major drop since the 21^st of July. All of these stocks with the exception of New Oriental Education are listed in the US. Because of this, foreign investors are wondering if any Chinese stock listed in the US is safe. E-commerce giant Alibaba have been hit by the aftermath of the crackdown, as they have fallen by 4.5% in reaction to the July 23 news. However, upcoming earnings calls for Alibaba’s Q1 performance will release soon, determining whether they will bounce back or be slightly sluggish due to events. Shares of Chinese EV makers NIO (NIO), Li Auto (LI) and XPeng (XPEV) are between 5% and 6%. JD.Com (JD) stock is off almost 6%.

By looking at these figures, the industry that has dropped off the most is the
education sector. If China wants to steer the education and tutoring industry into a non-profit direction, then it would make sense that foreign investors would pull out immediately. A company that has losses early on can still be viewed as a good investment because of their future potential to make profits, as can be seen with ride-share companies (Uber, Lyft) & food deliver companies (DoorDash, Grubhub). However, if in the long-term there are no perceived profit opportunities, then it would be a bad investment at any point in time. This sudden shift to a non-profit model seems to be the case of the later where there are no long-term profit opportunities. This pivot by the Chinese government seems to be a move to help shrink the growing inequality in education that Chinese citizens are facing with expensive tutoring services that help the affluent leave those who are less fortunate in the dust. This move by China doesn’t seem to take into account foreign investors, and that is fine. Foreign Investors are now pulling out in a seemingly logical manner. Although, fear-mongering about the Chinese tech sector as a whole isn’t helping anyone. This whole fiasco started even before DiDi, in September 2019 when both Ant Group and WeChat refused to share data with state-owned Baihang, it became clear that large tech companies were inconsiderate towards the government’s requests. Eventually, this resulted in Ant’s IPO being pulled back. DiDi made the same mistake that Ant did, by ignoring requests, thus resulting in the consequences they face currently. It seems to be the case that China is taking a much more hands-on approach to regulating its big tech companies unlike the US and EU. Rather than pandering to big tech, as in the US, China is setting boundaries for the long term. Ant Group is a perfect example of China’s approach. Within 7 months Ant has finalized its new structure and is now talking about its IPO again. Experts in the Asian markets like Andy Rothman, an investment strategist with Matthews Asia, explains, “They are dealing with regulatory issues in a different way than Western governments deal. So normally, a Western government would lay out a regulatory structure in the early days of a new industry, like fintech being developed.” Whereas, China is much more reactionary, “The Chinese experience has been instead, to say to entrepreneurs, go ahead and give this a try. And then we’ll step in there after we see how it works and decide how to regulate it,” said Rothman. “And I think that’s what they’re doing now.” It seems that if DiDi just follows the rules like Ant Group, it will get back on track, because it would make no sense “to take the wings off of the private sector, which has been driving all the job and wealth creation in the country”, as Rothman explains. Ultimately, foreign investors should take a much more active approach in investing in China, rather than the passive approach of US companies. An active approach means picking individual stocks, on the other hand passive investing is where investors buy an index that broadly tracks the market, such as exchange-traded funds like SPY- the S&P 500 ETF