How China Bulls Lost US$ 1 tn in a Matter of Weeks

Chinese technology stocks had their worst month in July since the global financial crisis after investors dumped shares following a regulatory crackdown this week.

The Nasdaq Golden Dragon China index, which tracks Chinese technology stocks listed in New York, fell over 20%.

Shares of Chinese internet groups Tencent (of WeChat fame) and Alibaba fell by 16% and 10% respectively.

The Hang Seng index fell 8.3% while the CSI 300 index, an index designed to replicate the performance of the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange, fell 8%.

The sharp decline came after the communist Chinese Government grew increasingly concerned about the growing clout of internet firms and the massive hoard of data they collect from hundreds of million people.

What triggered the crash?

The sell-off in Chinese stocks began with actions against ride-hailing giant Didi.

China's cyberspace agency ordered the removal of China's largest ride-hailing app from app stores just four days after it was listed on the New York Stock Exchange. The listing was the largest by a Chinese company since Alibaba's in 2014.

Following that first domino, reports of a government crackdown on China's private education sector sent US-listed Chinese education stocks tumbling.

Chinese education stocks in Hong Kong also took a beating, with New Oriental Education & Technology Group, Koolearn Technology, and China Beststudy Education Group plunging more than 30% each on 26 July 2021.

Next, China's antitrust regulator ordered Tencent to give up its exclusive music licensing rights and slapped a fine on the company for anti-competitive behaviour.

Market concerns also extended into the real estate sector.

China's debt-laden property giant China Evergrande Group's plunged 13.4% on 27 July after announcing it would cancel a proposed special dividend.

The firm is one of China's largest property developers by sales. It has been plagued for months by debt concerns amid attempts by Chinese authorities to cool the wider real estate sector with new restrictions.

Has this happened before?

This is not the first time China has used its power to reign in large companies.

Earlier in November 2020, China suspended Ant Group's US$ 37 bn stock market listing, thwarting the world's largest IPO with just days to go.

The Shanghai stock exchange announced it had suspended the company's initial public offering (IPO) on its STAR Market, prompting Ant to also freeze the Hong Kong leg of the dual listing.

Why has the government embarked on this regulatory crackdown?

All signs point to the government's determination to ensure social stability, even if it spells near-term turmoil for capital markets.

President Xi Jinping has declared he will go after 'platform' companies that amass data and market power. His administration is particularly concerned about eradicating systemic risks.

The Cyberspace Administration of China, the internet watchdog, cited data and national security as its prime reason for investigating Didi and now mandates a data security review for all companies seeking overseas listings.

The government also blames widening social disparities on the online boom, particularly in the pandemic era, and is moving to address discontent among its people.

Should this have come as a surprise?

Not really.

While China has gone a long way in opening its economy (it has opened up to foreign investment and its firms compete internationally), one must remember despite all this, it's not an open economy and is quite protectionist by nature.

The communist party retains control over the direction of the country, maintaining its course of socialist development.

Almost all the large and successful Chinese companies are state-owned and the few major genuinely private companies (like Huawei, Lenovo, and Ali Baba) have close links with the government.

State enterprises, albeit highly efficient and competitive, dominate banking, energy, and telecom.

What lessons on investing can be learned from this crash?

First, technology stocks are risky. Not only in China but all over the world.

The European Union has been at the forefront of tightening the rules on big technology players.

It announced the GDPR (General Data Protection Regulation) in 2018 which gave citizens a stronger say over what firms could do with their data and served as inspiration for lawmakers outside, including in Brazil and Australia.

The GDPR also spurred more discussions on data protection in the United States. Although there is no data privacy law at a federal level yet, in 2020 California became the first state to introduce personal data rules similar to Europe's GDPR.

Second, qualitative factors such as regulatory changes, or stability factors such as mass riots, civil war and other potential events need to be factored in while making an investment.

China can be best described as a communist country with a veneer of market economics which makes it a country with heavy regulatory risk.

As per Fitch Ratings, the regulatory risk in China's internet sector is expected to remain elevated with the government taking actions to prohibit certain monopolistic acts to protect market competition and safeguard the interests of users through anti-trust regulation, anti-monopoly penalties.

With little visibility on the government's next move, many investors could experience a high level of risk.

While investing isn't exactly "riskless", investing in companies from different regions could lessen the blow of a downturn. Or a regulatory shock like the one in China.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...