China stocks have had a roaring few weeks, but serious risks and deep uncertainties remain. Should investors believe that US-listed Chinese stocks are making a comeback, or should they adopt a more cautious stance?
You may have caught wind that Chinese stocks are supposedly on the last legs of a bear run, and are now poised for a bull rally.
This optimism is not unfounded, especially considering the strong performance put on by China and Hong Kong shares from May this year, which continued unabated until July.
Lending more credence to the bull rally hypothesis is the fact that Chinese stocks have been moving in clear defiance of the rest of the world.
This is most starkly seen when compared against the S&P 500. Here have a look:
CSI 300 vs S&P 500 past six months performance. Source: Google Finance.
On the left is the CSI 300, which tracks 300 of the largest companies in China, and on the right is the S&P 500, which tracks the top 500 companies in the US.
Notice how from May 2022 onwards, it’s a nice upward slope for the CSI 300, while over at the S&P 500, it’s basically a massacre? In a nutshell, that’s what everyone’s on about.
So startling is this development that some analysts even started naming Chinese stocks as safe havens.
Now, for retail investors outside of China, the best way to take part in China’s economic rise is by buying stocks and shares listed in other jurisdictions, such as the US and Hong Kong.
Thus, investors around the world are understandably turning their attention back to Chinese stocks listed on the US stock exchanges, prompting the question: Are US-listed China stocks making a comeback, and should investors start buying them again?
What’s behind the recent Chinese stock rally?
For those new to the party, here’s a short summary of what’s been happening in China stocks, and how the recent rally came to be.
It all started with an ant.
Specifically, the US$37 billion IPO of Ant Group, which was squashed by Chinese regulators when owner Jack Ma made some unfortunate remarks against China’s ruling party.
Back then – this was in November 2020 – Chinese tech stocks were riding high after two decades of a largely relaxed regulatory environment, which helped foster the rise of some of the world’s largest and most powerful companies.
The crackdown ushered in a period of uncertainty for the country’s tech companies, which up till then had been seen as sure winners. Action against other tech giants quickly followed, dealing further blows to investor confidence – already weakened after a battering by COVID-19.
All these brought about a sneaking suspicion among analysts and investors that the halcyon days of sky-high growth in the two decades pre-crackdown had come to a close, never to be seen again.
The gloomy outlook – darkened by worsening global conditions brought on by the Russian-Ukraine war – even prompted JP Morgan’s by-now-famous gaffe earlier this year in which Chinese stocks were deemed “uninvestable”.
The fallout of JP Morgan’s remark was swift and severe. Investors stampeded out from Chinese stocks across nearly all sectors, causing the Hang Seng Index to fall to a 10-year low in hours.
Things worsened in April and May as COVID-19 outbreaks in important economic centres Shanghai and Beijing prompted widespread lockdowns, further jamming up supply chains, while fears of US sanctions should China openly back Russia’s invasion reared in the background.
Yikes, could things get any more worse?
Thankfully, by June, the maelstrom had abated.
Regulators signalled a softening in stance, while Chinese tech giants such as Alibaba, Meituan, Baidu, etc posted better than expected earnings reports.
The sector was given a further boost by the unexpected-but-welcome approval of 60 new video game licences, and the imminent wrapping up of an official probe into data security breaches at ride-hailing giant DiDi Chuxing.
As the positive developments rolled in one after another, investor sentiment improved. The simultaneous declines in US and Europe stocks due to interest rate hikes and soaring oil prices also helped polish up China stocks in the eyes of analysts.
All these have contributed to the winning streak charted by Chinese stocks in recent weeks, but investors shouldn’t celebrate yet.
While the recent surge in stock prices is undoubtedly encouraging, it remains to be seen if the runway is clear for a bull run.
The risks ahead
There are three main risks ahead surrounding US-listed China stocks.
De-listing risk due to non-compliance with US regulations
In order to be listed on US stock exchanges, companies are required to comply with regulatory requirements, including full audit checks.
However, the Chinese authorities are wary, having long viewed auditing papers as state secrets. They fear that allowing US-based regulators access to the books of their most powerful companies could endanger national security, due to the sensitive economic data or information related to state-linked projects they may contain.
Both parties are unwilling to back down, putting an estimated S$1 trillion worth of US-listed China stock at risk of delisting. Should this happen, international investors will be forced to sell off their holdings, causing prices of Chinese stocks to crater.
Property sector liquidity crisis
China’s property sector has been in distress since 2020, when Evergrande, China’s largest property developer, declared insolvency to the tune of US$305 billion.
This sparked off a series of downstream contagion, and nearly two years on, the Chinese authorities have yet to find a solution to the crisis.
Things have become so bad that homeowners are now outright refusing to pay their home mortgages (properties in China are sold before development begins, with the proceeds used to fund new projects), further worsening the liquidity crunch in the US$1.7 trillion market.
If the property sector should collapse, the resulting shockwaves will impact the rest of the Chinese economy, dragging down Chinese stocks across the board.
Global recession fears
And thirdly, we can’t ignore the very real possibility of a global recession looming over the horizon.
The Russian-Ukraine war has dragged on far longer than expected, inflation is continuing to go up, central banks are raising interest rates, and the supply chain has yet to fully recover from the COVID19 pandemic.
Should the global economy fall into recession, the added pressure could cause the Chinese economy to buckle, interrupting the expected bull run in US-listed Chinese stocks – or even wipe out past gains in the worst scenario.
Conclusion: Proceed slowly, and observe for clarity
The greatest enemy when investing in the stock market is uncertainty, and conditions are as messy as they can get right now.
As such, the prudent investor may want to wait for greater clarity – clearing the US regulatory requirements is a big one – before proceeding.
For those who believe that a lucrative opportunity is up for the taking, caution is warranted, lest you find yourself overexposed and forced to take painful losses.
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