Hong Kong and Chinese stocks are pausing for breath Friday after an intense two-day rally, the strongest since the results of the Asian financial crisis in 1998. The Hang Seng is up 15.9% despite moving 0.4% lower today. But is the beaten-down tech and consumer sectors that have seen the most startling gains.
The Hang Seng Tech Index advanced 31.7% on Wednesday and Thursday, combined. Big-caps such as Alibaba Group Holding (BABA) (HK:9988) have gained more than one-third, up 38.3% despite a 3.6% correction today. Its e-commerce rival JD.com (JD) (HK:9618) is up by exactly half, 50.7%, even after giving back 4.2% today.
Does that make sense? Not when you look at the profitability or the sales of the companies, no. The trading has nothing to do with fundamentals and everything to do with public policy. Official pronouncements out of Beijing and Shanghai are driving prices. Now we wait for the Chinese policymakers to deliver.
It is a reprieve for investors, a great week after a savage 18 months that sent the same stocks far farther south. Alibaba fell 77.0% from peak to trough, its Hong Kong shares falling from HK$309.40 to HK$71.25. JD dropped 61.4%, from HK$419.80 to HK$161.90. Performance for the U.S. listings follows suit.
The Hang Seng was the world's worst-performing major exchange last year, and is still 27.3% below its levels last summer. Stocks would not have been performing so poorly in the first place were it not for the heavy hand of the mainland government.
It's great to hear that U.S. and Chinese regulators are working on a compromise that would allow Wall Street listings for Chinese companies to continue. Liu He, one of China's vice-premiers and its top trade negotiator, says a deal is in the works. He also told a committee meeting for China's cabinet that Beijing will offer policy support to the capital markets, as I outlined on Wednesday. Now investors will want proof.
The most-notable aspect of the comments from Liu, the top economic adviser to President Xi Jinping, is that they suggest the economists and regulators in the ranks of the Communist Party are wresting back control. A series of market-moving pronouncements and law changes in the name of Xi's quest for "common prosperity" over the last 18 months indicated that the president cares little for capitalist concerns.
It would not normally grab the headlines to hear the meeting conclude that "the most important thing is to insist that development is the first priority of the party," but this has come into doubt. These comments "appear to be the strongest ones we have heard from Beijing in recent times suggesting support for growth and financial markets," according to Nomura's equity strategists. "Admittedly, these comments need to be followed up by actions," the strategists add, although Beijing "may have likely put a floor under Chinese stocks for now."
On the concrete side, literally, we hear that China's finance ministry has decided that the nationwide rollout of a property tax has been put on hold. "There are no suitable conditions this year" to take the tax beyond a pilot program, the official news agency Xinhua quotes an official as saying. A property tax has been in the works for years, and has been trialed for a decade already in Shanghai and Chongqing. But the ministry has now decided it will not this year follow through on the government's pronouncement last October that it would expand the tax elsewhere.
The conditions are not suitable because of other government policies. Beijing is forcing the deleveraging of the property industry by demanding that developers get themselves under "three red lines" limiting how much they can borrow. Developers have to maintain a liability to asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash to short-term debt ratio of more than 1x. It requires the entire industry to recast the way it casts concrete; only 6.3% of Chinese developers could satisfy all three red lines at the time of their introduction, S&P calculated. It's a punishing schedule of debt reduction that makes it very hard for the developers to build.
Property, education, entertainment, e-commerce, food delivery, Big Tech in general - they've all experienced policy shifts that have delivered wild market swings, and investors have had no recourse. Entire industries such as private after-school tuition have been eliminated, with the Communist Party in July 2021 ordering the sector to turn non-profit. That destroyed a US$120 billion industry. "Beijing administrators are finding new ways to scare investors daily," I pointed out at the time, and the companies concerned have not recovered, even in this week's rally.
Two New York Stock Exchange listings in the Chinese education sector have taught us a painful lesson. TAL Education Group (TAL) is still down 98.3% from highs set in February 2021, when whispers from within the party ranks suggested that there would be changes for tuition centers in store. New Oriental Education & Technology Group (EDU) shares are down 94.5%. Analysts predicted that there would be tweaks around the edges of the sector, a call that proved very wrong. Nomura said an extreme case "will NOT happen," and the bearish scenario painted in some reports would not come to pass because "the industry would be devastated."
It is devastated. There were none of the months-long comment periods that a regulator such as the U.S. Securities and Exchange Commission would offer industry participants before making a significant regulatory change. Instead, we fed on breadcrumbs of sayings out of official meetings before a weekend announcement that tutorial education in China would change that Monday. TAL and EDU remain penny stocks, bouncing around their bottom.
China long ago stopped being a Communist country in practice; it became a capitalist nation with a dictatorship sitting atop it (many of whose members are phenomenally wealthy themselves). Xi has recognized that fact. His attack on the "disorderly expansion of capital" has constituted an attack on that capitalist framework, once again throwing China into an era of Maoist-style programming. Xi Jinping Thought is bearing more in common with Mao Zedong Thought than the market-friendly reforms begun under Deng Xiaoping.
But Mao's thinking largely championed the peasantry, a rural revolution to overcome "decadent" modern society. It's not exactly structured to cater to e-commerce, courier delivery, and the residential complexes with dozens of skyscraper towers that now house China's overwhelmingly urban population. Two-thirds of the Chinese people live in cities, according to the last census; 20 years ago, the situation was reversed, with two-thirds in the countryside.
As a result, Chinese Communist theory is clashing with Chinese Communist reality. Even the zero-Covid strategy pushed so heavily by the central government is requiring work. This week, we have heard from Xi for the first time that it's important to control Covid "with minimum cost," and that it's necessary "to reduce the impact on socioeconomic development as much as possible." There has been no mention of economic costs in the past, when entire cities were shut down.
I doubt stock markets will be front of mind when Xi and President Joe Biden talk on Friday, as they are scheduled to do. Biden plans to warn Xi off offering support to Russian counterpart Vladimir Putin, at a time that Beijing's silence on the Ukraine invasion amounts to tacit support. China is walking a tightrope, likely surprised by Putin's ferocity in Ukraine, and even-more surprised by the staunch resistance that Russian troops have encountered. The longer the war drags on, and the worse Western sanctions on Russia bite, the more pressure China is under to deliver on its promises to its ally, a friendship that in February Putin and Xi said has "no limits." And the more likely China would face sanction if it does help.
Investors, however, should hope that Xi concentrates his efforts on politics and international relations. Another key line out of the cabinet meeting this week is that "any policy that has a significant impact on the capital market should be coordinated with the financial-management department in advance, to maintain the stability and consistency of policy expectations." The regulators and economists must have a say.
It's dry language, but stability and consistency - not US$80 billion swings in the value of your biggest tech name, or 50% stock-price gains in one of your largest corporations - is what the Chinese markets need right now. We're poised not looking at company performance, but what policymakers will say, and especially do, next.