“China Tech Crackdown”, this headline phrase has frequently appeared in the financial news lately and it has turned the stock market upside down. Many familiar names such as Alibaba, Tencent, Meituan, and JD.com, have dropped 40% to 50% from their peak. Didi, which presented an IPO one month ago, lost half of its value and the rumour on the street is that it will be delisted from the US exchange.
Why is China crashing its own tech giants? Is this an opportunity for you to buy these stocks at such a huge discount? Should you average down if you already own these shares?
Many people are offering advice in the forum such as “a crisis is an opportunity” and you should “buy the dip”. As someone who has experienced first-hand the booms and dooms of China’s economic development and stock market for the past decades, I want to share with you my two cents and I hope this article can help you make a more informed decision.
The market price is always right, there is no such thing as undervalue
If you read my article in December 2020, I said Chinese tech stocks “are undervalued for a reason.” – because “they operate under different market conditions”.
I may offend a lot of people by saying this, but I think if you believe you can buy so-called “undervalued” stocks, you are assuming most other investors are dumber than you. And that is not a good start.
The stock price reflects what is happening to the company most of the time and we need to respect that. It may deviate from reality over a short time frame but it often corrects itself.
The massive China tech sell down is not just about Alibaba and Tencent. The bloodshed from the regulatory crackdown is everywhere. The ETFs that track Chinese technology companies such as Hang Seng Tech ETF and KraneShares CSI China Internet ETF (KWEB) have lost 40% to 50% from just 5 months ago respectively. And this happened against the backdrop of the Nasdaq (the US tech index) as it reached a new high every month.
Overall, the average Chinese tech stock price is 60% lower than its US counterparts! So unless there is a significant change in the fundamentals, the downtrend might not be over any time soon.
You need to be aware that the same people who called Chinese tech stocks “undervalued” have continued to call them undervalued for a very long time and every purchase they made has been losing money.
Many stocks may eventually recover given a long enough period. But this is not because the stock was undervalued, it is just because the economic cycles rotate. And since it takes a long time, you need to ask yourself, “How long am I willing to wait?”
You may think you just need to wait for a few months or even a year, but the reality can be more painful than that.
You can’t invest in China stocks by listening to CNBC
To me, this is the most important concept for you to understand when we analyze what is happening in China. Specifically, it is not easy for an English-speaking investor to invest in Chinese stocks when your only sources of information are from CNBC, Yahoo Finance, and the ‘talking heads’ on various blogs. Most of the writers do not even speak or read Chinese. Sure, you can google translate an announcement from the Chinese government or a Chinese company, but you probably won’t have a clue what it actually implies. It’s a question of trying to make sense of the information so that you can make an informed decision.
This reminds me of how I felt in 2015 when I met a fund manager who specialized in investing in Africa. How the western world understands China’s financial markets is like how wrong we understood Africa back then.
This can all be very confusing because, a great many Western (including Singapore) investors believe they are quite familiar with Alibaba and Tencent and these companies do look like solid ones to invest in, especially if you compare them with their US counterparts which are Amazon, Google, Facebook, etc.
And you may be even more convinced if you know China’s tech firms have more advanced technology than their US counterparts such as in the areas of Artificial Intelligence and Big Data analysis.
So when these stocks are at a 50% discount, it looks like a “crazy buy” opportunity from a value investing point of view. I saw some people in the forum share their trade screenshot like a badge of honour as they were proud to be “buying when others were fearful”.
The problem is that they are looking at China stocks through the lens of a capitalist. However, let’s be clear about this, China is not a capitalist country.
Here is a good example. On 29 June 2021, just before the IPO for Didi Chuxing (the largest Chinese ride-hailing giant) listed in the New York Stock Exchange, the famous Jim Cramer went public and told everyone that they should “Get as many shares as you can”. Unfortunately, by following his advice, many Americans (including our dear Temasek holdings) lost half of their investments in less than 30 days.
But if you understand the backdrop of Didi’s listing, you may not want to touch Didi at all at that time. Do you know on its biggest day of listing as an IPO, Didi’s executives kept low profiles, declining to ring the opening bell or even celebrate the event on Didi’s Weibo social media channel?
Why? I will explain later.
Buy and hold doesn’t give you a free pass to make money
For those who are vested, it is natural thinking to average down. They think this way because they suffer from anchoring bias.
Additional Reading: How Anchoring Bias Leads You to Bad Investment Decisions
Very often, you are told to buy good companies and hold them for the long term. The assumptions are that good companies can ride out the economic booms and dooms and eventually your share price will go up. That is why “value investors” advocate for you to buy on the dip or practice dollar-cost averaging.
They give you examples of Amazon, Google, Microsoft, etc. and how you too can benefit by not letting go of these shares. What you are not told is you are given these examples in hindsight, and that many companies failed or disappeared from the public eyes with natural death. Think about it, there are about 630,000 stocks in the world. What are the chances that you will pick the right stock to be standing strong for the next two decades?
When I started investing 15 years ago, the almighty stocks were not your familiar FAANG stocks, namely Facebook, Amazon, Apple, Netflix; and Alphabet (formerly known as Google). They were the energy giants such as Esso and Shell. And look what happened to them in the past decade. They have become the forgotten names.
Additional Reading: Why a buy and hold strategy makes little sense.
So why do you think the same technology stocks that people are worshipping today can continue growing forever? Currently, the average tenure of S&P 500 companies is 15-20 years. Do you realize that there is a high chance that you will outlive your stock holdings?
The other aspect you need to be very careful about is “averaging down” (buy more stock when its price gets lower) because it assumes you have unlimited capital. If you keep on buying stocks when the share prices go down, at some point in time, you will run out of your investment capital or you will be overexposed to a certain stock. The logic of the practice will work against you.
A good example is New Oriental Education which you may not be familiar with, but it is known to everyone in China. New Oriental was an aspiring story (just like other stories such as Haidilao and Nongfu Spring). The company was founded in 1993 by Yu Minhong, an English teacher at Peking University. He initially focused on the TOEFL and GREs but then expanded the company to provide services for various other exams and fields as well. The school is now one of the largest companies in China.
The company was listed in the New York exchange in 2006 and never had a negative year for the past 15 years and the revenue and earnings have always been going up year after year.
And guess what, 15 years of performance was wiped out in 3 months when the Chinese regulator decided that “education should be non-profitable” and the regulator cracked down on the after-school tuition industry. It may be unfathomable from a capitalists point of view, but that is the harsh reality of investing in a non-capitalist country while money is not everything.
China is not cracking down on tech giants but rather on foreign capital
When I looked back at my earlier article about investing in China stocks and Hang Seng Tech, I have mixed feelings. I think China’s investment climate is heading to a structural change. To understand this, we need to understand the history of China’s financial market.
China started on the path of economic reform and began opening its markets (改革开放) in the 1980s. The first modern stock in China was 小飞乐（600651), which was only listed on 14 Nov 1986. Amazingly, the stock still exists today, though it is not doing very well.
China’s stock markets, the Shanghai stock exchange (SSE) and Shenzhen stock exchange (SZSE) were only established in 1990. Compared to the US, the history in China’s capital market has been very short.
What is little known to the outside world is that the Chinese people haven’t benefitted too much from the activities in their stock markets. The real beneficiaries are the foreign financial institutions who made a fortune due to the boom and doom that took place in these stock markets.
It is a big topic and I will try to write more in the future. But you can refer back to my recent article if you would like to know more about how the US influences other countries through the financial system.
The point here is that China knew very well what was happening, but it was a win-win situation. China needed the capital and the US needed the labour.
Additional Reading: Goldman Sachs rules the world.
If you understand how the Asian Financial Crisis happened in the 1990s, that is why China had currency controls and tight oversight in the financial market.
About 10 years ago, China decided to open their capital market against the backdrop of globalization. They have done a lot to give foreign investors more access to their market. But since Trump was elected in 2016, the atmosphere has totally changed.
The resulting US-China tension and Covid-pandemic have eventually led to a de-globalized world and China has decided to move to “dual circulation”. This is a strategy to reorient China’s economy by prioritizing domestic consumption (“internal circulation”) while remaining open to international trade and investment (“external circulation”). Fancy words! But to me, it is increasingly clear that “dual circulation” means decoupling from the world.
So why does this matter?
Just now I mentioned Didi listed their IPO in an extremely discreet manner. And they obviously knew that this IPO was not going to end well. But why did they still insist on doing so? My wildest guess is that a company has to serve the shareholders and the biggest shareholder is Masayoshi Son’s Softbank Group as well as many other venture capitalists. They needed to cash out!
The shareholder structure of the China tech companies may surprise you:
- The biggest shareholder of Alibaba is Softbank (a Japanese multinational conglomerate)
- The biggest shareholder of Tencent is Naspers (a global Internet group and technology investor)
- The biggest shareholder of JD.com is Walmart (an American multinational retail corporation)
So while it may appear that China is severely regulating their own companies, the real people who are hurting are the foreign capitalists.
Yes, China investors may suffer too. But the foreign institutional investors are definitely suffering more pain. And the ones who are caught in the crossfire are retail investors like you and me who often buy China stocks from the Hong Kong and US markets.
Investors are the despotic landlord.
In Feb this year, China’s President Xi praised the Chinese Communist Party’s efforts to successfully help the poor peasants. He mentioned the revolutionary activities of “打土豪，分田地”, which means “attacking the despotic landowners and distributing their land to the poor”.
If you think about it, in the past, the biggest resource for an agricultural country was land which was controlled by the rich landlords, who enjoyed a lavish lifestyle by paying peanuts to the peasants for their hard work.
To a certain extent, in today’s world, the internet giants exist in the same form and they are exploiting the merchants and consumers in the same way.
Admit it or not, when you choose to invest in such a company, you choose to be the despicable capitalist who only wants the company to maximize profit so the share prices go higher. A listed stock is not a charity, when you make a lot of money, someone has to foot the bill. So when China decided that Meituan should have a minimum wage, Meituan (3690 HK) declined more than 27% on the same day and 17% on the next day. It is a policy that is against you as the capitalist.
In the western world, capitalists are worshipped. Warren Buffett, Jeff Bezos and Elon Musk are models of successful people that investors or entrepreneurs aspire to become one day. But does the Chinese look at them the same way? Maybe not.
Let me summarize…
Are Alibaba, Tencent and other Hang Seng Techs good solid companies? Yes, from a capitalist’s point of view. But the environment has changed. Let’s be honest, if we agree that the Chinese regulator is serious about the new anti-trust laws, then these companies’ “monster growth” period is over.
I don’t want to get into a debate of social ideology here, but China is taking the tough decision to sacrifice the capital market to reform the industries, and it is their choice. You and I as an investor, need to keep a clear head.
The way I look at it, it appears that China is moving towards anti-capitalism. And the crackdown is not going away any time soon. Even China is still placing a high priority on innovation, in the short term, the government appears to be more focused on equalizing the distribution of wealth and opportunities as it moves to address negative demographic trends.
From a money flow point of view, if you are a global equity manager, would you go against the trend and buy the dip? Or would you adopt a wait and see attitude?
If you have a strong heart and are “greedy when others are fearful”, you may be handsomely rewarded. Or, you may suffer dearly. Time will tell. But I believe that if you keep on swimming against the current, you may eventually lose your entire capital one day.
That is why I chose my investment strategy, namely, to follow the trend. It is not a new idea but it has helped me survive for years and probably decades to come.
Additional reading: Why you need a systematic approach to invest for retirements.
I am not saying the China tech share prices won’t go back up. But you may need to be really patient. Definitely, you will need to ask yourself, “How long am I willing to wait?”
Well, it is a long article again as I had a lot to share. I’d love to hear your opinions too. Feel free to leave your comment below.
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Thank you for you caution. I am in Beijing right now, and closer to the ground. I think the securities regulator is trying to calm foreign investors but the politicians are taking it another direction.
Hi, Emmanuel Daniel
Thank you for the update. I agree with you and understand the situation. The enthusiasm of foreign institutional investors to invest in China has dampened quite a bit recently.