With fear at its peak, is it time to hunt Chinese equities?

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From electric vehicles to e-commerce giants and online education, there is no shortage of Chinese companies attractive to US investors right now – at least on the surface.

After all, it’s not often that big Chinese stocks like Alibaba (NYSE: BABA) or Tencent (OTCPK:TCEHY) fall 50% or more and settle into price-earnings ratios more suited to consumer staples stocks than fast-growing tech offerings.

Indeed, some Chinese stocks have seen sudden increases as recently as March, suggesting significant chances for quick gains. For example, Nio (NYSE: NIO), Li Auto (LI) and Xpeng (XPEV) all saw swings of more than 20% in March as Chinese regulators appeared to take their foot in the gas from Beijing’s recent crackdown on hot companies.

Similar measures have also followed funding deals, and there is some optimism that a struggling Chinese economy will encourage state regulators to back some “national champions”.

Additionally, BYD Co. (OTCPK:BYDDY) outperforming its peers could provide perspective on the market bifurcation and an opening for stockpickers.

However, such apparent opportunities could be quickly wiped out by some significant overhangs associated with these stocks. For example, Chinese equities not only face potentially tougher regulation on both sides of the Pacific, but also a stubborn adherence to China’s COVID policies that could reduce any opportunity for even the most nimble traders.

In short, there is more than enough risk for any offender at this point:

beijing shoots down

The woes of the Chinese tech sector are well understood and boiled over so much that BABA founder Jack Ma virtually disappeared for a time.

Companies like Pinduoduo (PDD) and Tencent (OTCPK:TCEHY) have also set out to promote major multi-billion yuan investments to bolster a state-sponsored common prosperity agenda. Meanwhile, Chinese companies in the tutoring industry like Gaotu EduTech (GOTU), New Oriental Education & Tech (EDU) and Tal Education (TAL) have been decimated by crackdowns with declines of more than 90% the last year.

If these volleys were insufficient, the canceled IPO of Ant Financial and the upcoming delisting of DiDi Global (DIDI) should have been the final warning shots indicating that Beijing no longer wanted to let its biggest tech players mine US markets. .

Yet these impacts did not appear to immediately erode US investors’ appetite for Chinese ADRs. Quite the contrary. According to Reuters, the repressions and wild swings of summer 2021 only fueled record trading levels. Even the famously shrewd Charlie Munger was adding significant exposure at the end of 2021. As another cycle begins, there may be a similar temptation at play.

Indeed, the firepower touted by Chinese regulators so far might suggest that the worst is already over. In fact, BlackRock has made this argument many times over the past year.

The Larry Fink-led asset manager recommended boosting allocations to Chinese assets significantly late last year, adding that the risk-reward ratio was too great to ignore, even in the face of headwinds understandable.

But that dovish outlook was soon met with a replica from Credit Suisse in 2022.

“Monetary policy is eased while elsewhere it is tightened,” wrote the firm’s global strategist, Andrew Garthwaite, in January. “Economic momentum is accelerating.”

Many companies began publishing research adding to the bullish trend in the beleaguered market soon after. A common refrain came in the form of advising that the worst was already over.

“Yes, China is struggling with growth and a stronger dollar is not good news for Chinese stock markets,” read an HSBC report from early February. “But it’s now well known and its price is priced in. Even good blue chip stocks are now trading at attractive valuations.”

SEC Focuses on Audit Matters

Yet that reckoning quickly changed in the second quarter. This time, the US is the nation with its regulatory teeth kicking in and making those previously “attractive” valuations look downright lofty.

“As more and more China-based companies are listed in the United States, there are growing concerns about the lack of transparency in Chinese corporate accounting and corporate governance standards,” an SEC Risk Spotlight document said. “In addition to the risks associated with the inability to conduct due diligence to verify the soundness of accounting and governance standards…the design and control of the Chinese financial market by Chinese authorities creates a series of potential concerns for investors standards regarding disclosure, liquidity, volatility, fraud and risk management.

To address these risks, the regulator recently leveraged the Foreign Corporate Liability Act to add more than 80 companies to a list of companies to be delisted. This included Xpeng (XPEV), JD.com (JD), Pinduoduo (PDD), Li Auto (LI), Nio (NIO), Luckin Coffee (OTCPK:LKNCY) and NetEase (NTES).

Rather than fight this designation, it would seem that Chinese companies are accepting the pending decision. Indeed, NIO (NIO) is apparently already considering a possible secondary listing in Singapore as fully fungible with US-listed ADR shortly after acknowledging the regulatory warning from the SEC.

Luckin Coffee (OTCPK:LKNCY) followed suit on Monday, indicating its interest in listing in Hong Kong after being ousted from Nasdaq.

Meanwhile, stocks in China’s electric vehicle and tech spaces have faltered following regulatory filings to the point where they look increasingly fragile going forward. In the end, it may be Washington, not Beijing, that will put the final nail in the coffin for US-listed stocks.

The persistence of zero COVID policies

Even political and regulatory risks aside, the depressed valuations of many of these stocks may be reasonable on their face.

This is largely due to strict compliance with the containment policies pursued by the Chinese authorities, even in its largest metropolises.

A recent op-ed from the state-funded agency world times clearly outlines the government’s perspective. Citing the 267 million people aged 60 and over in the country, rejecting any calls to withdraw from its strict anti-pandemic measures.

“We should not ‘stay flat’ in any form, but should stick to the dynamic zero strategy, take the lead in epidemic control, and be strict in epidemic control. “, states the article. “So-called herd immunity basically means driving out large numbers of vulnerable people with low immunity. It is cruel social Darwinism. In contrast, China has protected the elderly and patients with underlying health conditions, which is very remarkable. »

The firmness of China’s adherence to this strategy was only confirmed last Thursday at a meeting of the Politburo Standing Committee. The organization is committed to “unwavering adherence to the general policy of ‘dynamic zero-Covid’.

The committee added that any doubts about party policy permeating public opinion should be dutifully quashed. As a pivotal National Congress of the Communist Party is expected in November, this should not be expected to change in the short term.

Sales of electric vehicles are plummeting and consumers are already overwhelmed as the housing sector experiences unprecedented upheaval, crushed by stay-at-home orders. This calls for caution on the whole Chinese economy.

Not to mention the supply chain constraints that emanate from large, economically important cities like Shanghai and Shenzhen.

Conclusion

Many traders have strong contrarian trends. After all, the best trades are often made just when other investors are capitulating.

For big tech names, capitulation is more likely to come in the form of companies wanting to continue listing in the United States. For others, like China’s online education sector that finds itself in the crosshairs of Xi Jinping’s flagship economic plans, there’s reason to believe these ventures aren’t long for this world. All of this just adds to significant macro overhangs that temper any modicum of enthusiasm that might yet be mustered.

That’s not to say there won’t be short-term rebounds. There will more than likely be signs of life appearing as fears fuel some fluctuations.

However, there’s a saying in Texas (and maybe even Tennessee) that if you get screwed twice, you can’t get screwed again. This malapropism may contain some wisdom amid the prolonged sell-off of Chinese ADRs.

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