China: To invest or to avoid?

A raft of regulatory reforms in recent weeks has hit stock prices – but there’s a deeper theme at work.
Image: Qilai Shen/Bloomberg

Over the past few months, announcements by the Chinese Communist Party (CCP) have sent shock waves around the investment world. And, with these developments dominating world headlines in the past few weeks, one must, of course, consider the impact the news has on investment prospects when it comes to China.

Stocks like Alibaba are down nearly half over the last year, Tencent is down by a third since the start of 2021, and troubled property development group Evergrande is down 80% since January.

Bloomberg reported on the series of steps taken by CCP leader Xi Jinping to wield the cudgel of state power in support of the squeezed middle class.

These steps included a clampdown on private tutoring, curbs on unaffordable housing, obligations on food delivery firms to pay a living wage, and data security reviews for Chinese tech companies seeking to raise capital abroad.

This was part of a wider crackdown on tech companies, as the CCP targeted specific companies like Tencent and Meituan, China’s largest on-demand delivery firm.

China’s new-found zeal for tighter regulations on all sorts of industries, but especially the tech sector, accounts in large part for the near halving since February in the Nasdaq Golden Dragon China Index (HXC), which is an index of US companies doing business in China.

At its most extreme, the Chinese crackdown on a swath of private sector companies erased $1.5 trillion in stock market wealth. Many of the hardest hit companies, like Tencent and Meituan, have since regained some of their losses, but it is clear that the CCP is in the process of redefining the social contract with the people of China.

Perspective

Iain Power, fund manager of the Nedgroup Investments Balanced Fund, says it’s important to look through the noise to get the facts.

“In the media we have obviously been seeing the developments and announcements by the Chinese government as they unfold. There has been particular focus on announcements that are targeting some of the areas where the Chinese government deems the actions of companies not to be in line with their long-term framework of common prosperity and reducing income disparities within Chinese society.

“This is important because some of the headlines we are seeing are very specific to the Chinese state’s approach to tutoring companies – and making some of these companies non-profit organisations virtually overnight – which has resulted in some significant, and permanent, destruction of wealth for shareholders.”

Power says the proposed reforms aim to achieve a better life for Chinese people and more, or equal, access to education.

Furthermore, the intention is that if education becomes cheaper, it will encourage people to consider having more than one child, in support of the Chinese government’s move away from the one-child policy that has been ingrained for so long.

Well-intended objective

“The other issue we are seeing is that the government is taking action to try and create a more sustainable society that supports ordinary people,” says Power.

“We can see this with some of the announcements that the Chinese government has made which haven’t been as high profile in the media – for example limiting the maximum weekly work hours of certain segments of workers that have been the victims of exploitation.”

While reform in the West is an often-tortuous process of lobbying and litigation, in China change can come quickly and without warning.

Says Power: “While we have seen pressure on share prices and the sense that the Chinese government is increasing their involvement in the state – and we must acknowledge that they are doing that – their long-term goal is on common prosperity which is a well-intended objective.

“Achieving this and addressing the huge disparity between the rich and the poor in China will, however, be a delicate balance to achieve.”

History has shown that too much government involvement in the economy doesn’t benefit it, no matter the admirable intentions of social justice and equality. The Chinese government will walk a fine line between maintaining sustainable growth while closing the inequality gap.

Another motivation behind the regulatory zeal of the government is the need for a cleaner environment, along with quality of life, education, health care and social services.

“We are already seeing lots of changes and we expect lots more to come in terms of regulation and legislative frameworks that ensure that companies change the way that they operate to become more sustainable and supportive of the environment.

“The crucial – and difficult – thing will be to achieve balance,” says Power.

A lot of these developments have very good rationale behind them but given the demand and supply nature of the economy there is always the risk that they go too heavy in terms of the control side, and this is the issue that is causing the concern for many businesses and investors.”

Brought to you by Nedgroup Investments. 

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