Are Chinese Stocks Uninvestable in 2022?

Chinese Stocks Remain Volatile?

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China is facing an abundance of risks that could peak in 2022 and 2023.?The bottom in its equities could be a generational opportunity for risk-tolerant investors. Or it could be the absolute worst decision to even venture into. I want to unpack some of the risks as I see them. Keep in mind these are mostly only my opinions.

Hey Guys,

The Headlines: China is suffering through a real-estate sentiment crisis and a Omicron stealth variant B.A.2 crisis. It’s biggest companies like Alibaba, Tencent and others plan massive layoffs in a significant purge of jobs.

Chinese Job Cuts coming for Chinese BigTech with Unemployment in Focus

Alibaba and other companies are also doing massive stock buybacks, after losing more than half of their value in terms of market caps. Without betting auditing Chinese ADRs may be kicked out of Western markets in the next couple of years, it’s all adding up to be a tremendously volatile time for Chinese companies and stocks.

The tech sector, which has been a prolific job-creating sector, is now awash with stories about frozen headcounts and lay-offs. After a couple of years of new regulatory scrutiny and crackdowns, Chinese BigTech is growing a lot slower. Unemployment in China is increasing and a zero-Covid policy may not make much sense with how contagious B.A.2 variant is.

Alibaba said on Tuesday it will increase the size of its share buyback program from $15 billion to $25 billion, effective for a two-year period through March 2024. $BABA had gone down to $76 and has now rebounded to $117. But I don’t think the pain is over for sentiment in Chinese stocks.

On March 16th, China said it will support Chinese IPOs abroad, calling for closure on tech crackdown, but we haven’t seen much so far. Days of worries about U.S. delisting risks, on top of existing concerns about economic growth, had sent Chinese stocks plunging in New York and Hong Kong.

A slew of Chinese real estate developers this week said they are either not able to release their financial results on time or have yet to set board meetings. We knew the Evergrande sentiment crisis wasn’t over and could spill into 2023 as well. This means confidence in China’s real-estate and stock system could face crisis levels, especially if massive lockdowns regarding B.A.2 continue.

China May be Powerless to Improve Sentiment in 2022

Chinese and U.S. regulators are progressing toward a cooperation plan on U.S.-listed Chinese stocks, state media said, citing a financial stability meeting in Mid March, 2022 chaired by Vice Premier Liu He. Positive earnings reports and announcements of share buybacks by firms such as Xiaomi and Alibaba have also likely buoyed investor sentiment. But is the macro picture really any different?

China’s partnership with Russia, seems to have dodged a bullet as they aren’t facing sanctions or much rhetoric from the West, but there are so many grave concerns now that China is facing simultaneously.

Alibaba said it had already re-purchased about $9.2 billion of its U.S.-listed shares as of March 18 under its programme, which was initially slated to last until the end of this year. That it will do $25 Billion will mean other Chinese firms will also do it, likely as an edict from the Chinese State. Still the destruction of tech-related jobs from content creation to private tutoring is translating into fears of a jobless tsunami including China’s crackdown on gaming hurts the bottom lines of a company like Tencent, even when its gaming sector is growing faster internationally than perhaps ever before.

Alibaba’s repurchase scheme will be effective for a two-year period through March 2024, the company said. I think it might take until 2024 to see Chinese stocks truly rebound, so how do you know when a bottom has been hit? The Mid March 2022 bottom of $KWEB was $21 and $YINN was $3, I would take that as a comfortable place to buy if we hit those panic levels again.

Chinese Stealth Omicron Situation Could Become Dire

The problem is lockdowns in China hurt small businesses and unemployment far worse than in other parts of the world. Since they are more strict and they get less financially help (often none). So if Covid-19 gets out of hand in China which looks rather likely now, the economic impact on unemployment could be really bad due to an already weakened real-estate and stock sentiment. China may value stability, but this is a very unstable time in China.

China has an abundance of incredible companies but its consumer is king and unemployment is a major treat. China claims an unemployment rate under 4% which is in 2022 hard to believe. When your biggest tech companies plan massive jobs cuts what will it do to confidence in your labor market?

China’s year-long campaign to clip the wings of the country’s Big Tech sector has taken a heavy toll and is now casting a long shadow over the employment market, a development at odds with the government’s goal of creating economic prosperity. That they decided to do this regulatory restructuring when its real-estate sector looks at the point of multiple defaults, is interesting to say the least.

“Alibaba’s stock price does not fairly reflect the company’s value given our robust financial health and expansion plans,” said Xu. - Alibaba Group’s Deputy Chief Financial Officer Toby Xu.

I have to agree but the structural challenges to China’s system remain, namely:

• Real estate default and sentiment crisis
• Stealth omicron going mainstream
• Massive BigTech layoffs and job cuts
• Regulatory uncertainty regarding Chinese ADR and auditing practices that are non-compliant with U.S. regulators
• A likely increase in unemployment and public discontent
• Potential economic sanctions due to their “partnership” with Putin’s Russia in a guilty by association scenario

Russia’s invasion of Ukraine poses a difficult question for China: How can it support a key strategic partner when relations with the U.S. and Europe are so much more important for its economy? All these various challenges really are a very difficult time for China and its biggest businesses.

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China’s Developer Debt Crisis Will Be Significant

China’s debt crisis with its real-estate sector might just be starting to show in terms of scale. Among them was troubled property developer Evergrande that hit markets last year with its debt crisis. But several others have since shown weakness. Nearly every week another Real estate developer in China shows it too is close to defaulting on its debt. China’s reliance on real-estate to both inflate economic growth and store its wealth was an absurdly risky gamble.

Investors appear divided on the outlook for Chinese stocks, despite recent positive signals from authorities in the country. I don’t think China is uninvestable, I believe China will easily emerge as the economic powerhouse of the 21st century. That being said it’s clear the 2020s are fraught with dangers. The West may choose to further try to isolate China, seeing it as not just an uncooperative growing power but a potentially dangerous strategic rival.

This is why seeing what happens with Alibaba, Ant Group, Didi, ByteDance and others is so interesting. China will eventually weaponize its top corporations globally to push the agenda of the state. As we have seen with the rise of ByteDance’s TikTok, they can now do this at scale that can out compete even Silicon Valley companies. Betting against this makes no objective sense. Yet many Western investors and even Wall Street analysts remain hesitant with the amount of regulation in China’s technology sector.

For China, the economic relationship with the European Union is much more important than with Russia. China even as it bans crypto and speculative Metaverse projects, will be on-side with the money, trade and global expansion. China’s economic engine and bigger population will fuel artificial intelligence innovation and consumer convenience mechanisms that are outpacing both Europe and America by quite a wide margin. That will translate eventually into better diversified companies. After Microsoft, Alibaba may in fact be one of the most diversified companies in BigTech.

As for the Real-estate developer debt crisis it will get a lot worse in 2022. There’s little doubt of that. Besides Evergrande, other developers cited the resignation of auditors for failing to issue their financial year 2021 earnings on time, according to Japanese bank Nomura. Housing markets are catching more than just a chill, as reported by the SCMP. In Shenzhen housing market, sales of lived-in homes shrank to 15-year low in 2021. That’s not just a chill.

As the Fed tightens and raises interest rates, China will be doing the opposite which is likely to eventually give its equity market a likely surge. Valuations are attractive at the bottom points of 2022, if you can catch them. This is especially true if you can invest in Hong Kong, considered a safer way to gain exposure to China’s growth. I personally see the ADR delisting of companies like Alibaba, at rather low levels, perhaps 20%.

Why China’s Systems Wins

China has pledged to maintain normal trade with both Russia and Ukraine despite a ratcheting up of sanctions by the U.S., Europe and other Western allies, as well as by Asian economies like Japan and Taiwan. If they are not careful they could face global sanctions depending on how this all goes.

China introduced sweeping new rules across the technology industry, often without warning, over the past 14 months. The moves shook investor confidence and wiped billions of dollars of value off the country’s publicly-listed giants. Yet it cannot afford to hurt the perception of Chinese BigTech much longer, even if there is more work to do to regulate them and enforce common prosperity into the system. China’s Neo-Surveillance capitalism is widely misunderstood in the west. It actually affords a level of B2B collaboration towards State goals that’s a significant advantage over free-market capitalism in the West, where it’s everyone for themselves on the dollar. China thinks more about the future than just dollars.

By being covered more by corporate nationalism and an agenda of China’s future place in the world, Chinese Capitalism can leverage its consumer and its influence on developing nations to its own economic advantage to achieve faster growth as its companies scale globally. Again, this is also widely misunderstood in the west. Nor can Western countries replicate this bonus advantage. You cannot clone Capitalism with Chinese characteristics, or steal its IP.

Still in the history of Chinese equities, market routs like these aren’t uncommon. Chinese citizens have piled their cash into real-estate instead of stocks, and it’s such a pity. Any market that falls around 30% in 10 days due to policy and geopolitical concerns — and then bounces back after the announcement of government support, is driven by policy and not the value or performance of its companies. I believe China will correct this over the 2020s, and its companies and their stocks will have more stability post 2025.

As of mid March, JPMorgan China Internet analysts Alex Yao and a team said they considered the sector “uninvestable” for the next six to 12 months, and downgraded 28 of the stocks they cover. Other analysts and investors see Chinese equities in their most beaten down state as massive value picks. But there are too many variables to make these stocks and this sector “safe” picks.

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