It has been a wild ride for stocks linked to China in recent years and, indeed, in recent days.
From fears over a former CEO's sudden disappearance in the case of Alibaba (BABA) , to a crackdown on gaming that curbed growth in popular names like Tencent (TCEHY), to the outright cancellation of listings in the case of DiDi Chuxing (DIDI) and Ant Group, persistent problems in regulation and governmental oversight have buffeted investors bullish on the nation's top stocks.
As of late, spiking Covid case numbers across China, including in tech hub Shenzhen for a brief period, have only exacerbated concerns about supply-chain problems that have pained investors in many of the same names.
While a violent swing to the upside that sent notable China-linked ETFs such as the KraneShares CSI China Internet ETF (KWEB) soaring in the past week might intrigue eager traders, investors are likely better off keeping their money out of Chinese stocks.
"Our overall view is this year, [the] China market is not an easy bull market," Bank of America China strategist Winnie Wu said in a sober assessment of the market. "It's more likely to be buying on hope and selling on fact and results."
Evergrande Issue Re-Emerges
One of the issues rearing its ugly head again recently is the Evergrande (EGRNY) crisis, which has not abated despite a recent fading from the headlines.
"The Company will not be able to publish its audited results for the year ended 31 December 2021 on or before 31 March 2022," the beleaguered real-estate behemoth announced in a surprising press release on Monday. "Shareholders and potential investors of the Company are advised to exercise caution when dealing in the securities of the Company."
The release was coupled with the announcement that third-party guarantors had seized over $2 billion in bank deposits from subsidiaries as the developer nears a major default.
While there are likely very few U.S. investors to be seriously hit by the default, the impacts for the Chinese market are potentially dire.
Per J.P. Morgan, the Chinese real estate market has grown over 400% since 2008, ballooning from only one-twentieth of national GDP to just under one-fifth. Price acceleration for these properties does little to impede concerns about a bubble either. For context, a recent paper from Harvard economist Kenneth Rogoff and IMF economist Yuanchen Yang highlights the fact that housing prices in China's Tier-1 cities have risen more than 600% since 2002, a rate nearly eight times as pronounced as the U.S. housing price trend from 2000 to its 2005 peak.
The paper notes that consumer behavior in terms of leverage follows the same trend. From 2013 to 2018, real estate investment increased by 30% alongside a rise in the household leverage ratio from 33% to 60%.
All of this is to say that a large percentage of the Chinese population, the middle class specifically, is indebtedly investing in real estate. Thus, a collapse of such a major developer could indeed have Lehman-like impacts in the market and crush consumer demand in the market. As one can readily glean, the dynamics of a housing collapse abetted by this major institution are very much analogous to the situation the U.S. saw in 2008.
As such, any more adverse news from Evergrande would likely have heavy impacts on automakers like Nio (NIO) , Xpeng (XPEV) , and the aforementioned internet stocks.
To be sure, the authoritarian Chinese state has many more tools to let the air out of the proverbial balloon.
"Authorities should timely respond to issues that draw attention from the market," the financial stability and development committee under China's State Council said last week. "The financial stability and development committee will strengthen coordination and communication under the guidance of the CPC Central Committee and the State Council and hold relevant parties accountable if necessary."
Geopolitical Positioning
Yet, while the Chinese state may aid investors in the case of Evergrande, its ambivalent stance amidst Russia's invasion of Ukraine is less encouraging.
With somewhat contradictory statements about respecting territorial integrity, support of Russia in a "new era of international relations," and potential mediation of the conflict, the nation's role is perfectly undetermined. Further, China has irked many U.S. policymakers by peddling Russian disinformation campaigns about U.S. biolabs in Ukraine in state-backed media.
As of late, President Biden, whose administration has indicated that Beijing had advance notice of the invasion, has made clear that China is not immune from bearing responsibility should it make a move toward a firmer alliance with Moscow.
"President Biden made clear the implication and consequences of China providing material support -- if China were to provide material support -- to Russia as it prosecutes its brutal war in Ukraine, not just for China's relationship with the United States but for the wider world," a White House statement reads. "And he stressed concerns, as you've heard us speak about more broadly, that Russia is spreading disinformation about biological weapons in Ukraine as a pretext for a false-flag operation and underscored concerns about echoing such disinformation."
While the ambiguity of China's current positioning prevents any significant action by either the U.S. or EU, any shift could bring about significant sanctions as was laid out in the case of Russia. Of course, any move in this direction would be catastrophic for U.S.-listed Chinese stocks.
The Death Knell of Delisting
A final fact that should serve as a significant wake-up call above all else is the watchful eye of both the SEC and the Chinese state, each of whom is souring on dual-listed shares.
"There are some discussions ongoing at the moment between the two sides, but these discussions have been going around in circles for quite a long time," Jamie Allen of the Asian Corporate Governance Association said in an interview with CNBC this morning. "Unless there is some change in the geopolitical relationship between these two countries, it does seem to us that in two or three years you will start to see delisting."
This expected exodus has already been reflected in outflows from Chinese stocks thus far in 2022. According to the Financial Times, non-Chinese investors have shed $6 billion worth of Chinese shares in just the first quarter of this year.
It would seem overall that the "Chinese Dream" has been a nightmare for investors eager to capitalize on what otherwise would seem dirt-cheap valuations. However, as many have found out the hard way, cheap valuations are often cheap for good reason.
As the exodus of investors from Chinese stocks continues and the threat of broader delisting looms, investors intrigued by the wild swings in many of these stocks may be better served to watch from the sidelines. Otherwise, they may find themselves holding quite a hefty bag.
