China’s regulatory crackdowns on technology companies are part of deeper reforms taking place over the next five years that have a stronger emphasis on anti-trust enforcement, one fund manager says.Thomas Peter/Reuters
Stocks of Chinese companies have been roiled amid a regulatory crackdown in recent months that has targeted a wide range of firms from technology giants to those involved in after-school tutoring, food delivery and ride-hailing.
Although some bargain hunters have waded into the market, investment experts urge caution when buying the dip, given the remaining uncertainty, and say investors should focus more on companies with domestic policy tailwinds.
“We are cautious over the very short term, but we do think that a significant buying opportunity is imminent,” says Tyler Mordy, chief executive officer and chief investment officer at Forstrong Global Asset Management Inc. in Toronto.
“The hallmarks of a Chinese stock market bottom are here – not least because investor sentiment is deeply negative right now,” he says.
With Chinese stocks trading at a big discount to their developed market counterparts and Beijing’s reflationary efforts just starting, “a sustained Chinese stock market rally in the not-too-distant future is highly likely,” he says.
When investing in China, always look for signals of policy shifts, says Mr. Mordy, who oversees exchange-traded fund (ETF) portfolios at Forstrong. “This stock market is very policy-driven.”
For example, Forstrong sold off its holdings in KraneShares CSI China Internet ETF KWEB-A late last year after China increased its rhetoric on the technology sector. That culminated in the suspension of a planned initial public offering by Ant Group, an affiliate of e-commerce giant Alibaba Group Holding Ltd. BABA-N, in November. This ETF, which owns Chinese tech stocks, is down 50 per cent from its February peak.
Battered tech stocks are not compelling because they’re “richly valued and are still in the crosshairs of China’s regulatory crackdown,” he says. “We don’t expect Chinese policy makers to back away from breaking up big-tech monopolies.”
The opportunities lie with Chinese companies known to be aligned with the government’s long-term policy agenda or that got caught in the downdraft amid “the indiscriminate liquidation across all sectors,” he says.
“We like the banks in China and the consumer discretionary sector – anything that would be more along the lines of the value side,” Mr. Mordy says, adding that these stocks are primed to benefit from “a new credit cycle coming out.”
With China’s economy slowing more than expected in July, that “will push the policy pendulum toward reflation,” he says. For example, the People’s Bank of China recently cut the amount of cash that banks must hold as reserves.
“We will likely have a central bank interest rate cut before the end of the year,” and fiscal policy will become more pro-active, he predicts. China, he notes, is the only major government bond market in the world that still has positive real yields.
Regina Chi, vice-president and portfolio manager with AGF Investments Inc. in Toronto, agrees that “caution is definitely warranted,” particularly in sectors that may be hit with or see more government regulation.
China’s market has become bifurcated with those involved in areas such as data and cybersecurity coming under scrutiny for becoming too big, while others in sectors such as electric vehicles, 5G wireless technology and automation continue to grow with government support, she says.
Ms. Chi, who oversees China and emerging-market equity funds, favours companies that can benefit from China’s ambitious goal to become carbon-neutral – meaning the country’s net carbon emissions will reach zero – by 2060.
One name she likes is China-listed Nari Technology Co., a supplier of power and automation technologies, and also the country’s largest secondary, grid-equipment manufacturer. It is involved with the onboarding of renewable energy onto the grid and is at the forefront of smart-metering technology.
Hong Kong-listed Wuxi Biologics Cayman Inc. is also attractive, she says. Wuxi is a leading contract research and manufacturing company that provides platforms to help develop biologics – drugs made from complex molecules manufactured using living micro-organisms, plants or animal cells.
Wuxi’s stock was hurt on concerns about potential regulation in the health care sector “but we don’t believe this will be the case,” she says. “We are stock-pickers, so we look at individual stock valuations.”
The big surprise from this summer’s regulatory crackdowns has been the “speed, scale and intensity,” she says. Beijing unleashed regulations for covering everything from private education to internet-oriented tech companies and overseas listings.
China recently banned after-school tutoring companies from making a profit and raising capital in foreign markets. The crackdown is part of a policy shift to China’s goal of “common prosperity,” she says, referring to Chinese President Xi Jinping’s rhetoric on closing the country’s wealth gap.
The regulations are aimed at reducing the financial burden on parents to give their children an edge. By cutting educational costs for raising children, China hopes to reverse a demographic decline. This year, it raised its two-child policy to three.
On the other hand, the crackdown on companies in the digital world, “which includes players such as Alibaba, Ant Group and Tencent [Holdings Ltd. TCEHY] are part of deeper reforms [taking place] over the next five years that have a stronger emphasis on antitrust enforcement,” she says.
Over the long term, the worst-case scenario is that innovation will slow down if Chinese companies can’t get access to capital markets because of restrictions, and expansion and growth plans could take five or 10 years, she says.
“We are at a significant moment in the history of the Chinese economy and capital markets,” Ms. Chi says, noting that Beijing is shifting its priorities from growth to balancing growth and social stability.
Yan Wang, partner and chief emerging markets and China strategist at research firm Alpine Macro in Montreal, warns that the regulatory crackdowns “are not short-term events,” and that it’s possible that other sectors have yet to be targeted.
“We remain cautious in the near term,” Mr. Wang says, adding that his firm has been anticipating a correction in risk assets, including Chinese stocks. “The regulatory crackdown remains a near-term uncertainty and Chinese growth will likely continue to decelerate.”
While Chinese tech stocks have fallen sharply from their peak, “there’s a case to be made to be long on this sector, especially for investors with a longer time horizon,” he says. “But volatility will likely remain high in the near term.”
If investors want to increase their exposure to China, “they should focus on value and avoid growth stocks,” he says, noting that “the valuation gap between Chinese value and growth stocks is unsustainably high.”
Still, Mr. Wang has been recommending Alpha Macro clients be overweight on China in their emerging-market portfolios.
“The country’s deteriorating growth momentum will force the authorities to ease policy, which will eventually help the Chinese economy to stabilize and accelerate toward year-end,” he says.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.