China's Government Offers a Little Regulatory Clarity

Editors’ Note: In the course of discussing a broader topic, this article touches on a couple of individual companies. As a reminder, MarketMinder Europe doesn’t make individual security recommendations. Those mentioned are merely to support the broader discussion.

What a difference a day makes! On Monday and Tuesday, as investors digested news of a lockdown in Shenzhen—a high-tech manufacturing powerhouse—Chinese stocks fell -13.1%, extending a slide that began over a year ago.^[i] This also followed a selloff last week, when a few small, US-listed Chinese firms were put on watch for removal or delisting from US exchanges by America’s securities regulator, the Securities and Exchange Commission (SEC).^[ii] Yet Wednesday was very different. Whilst Brits were sleeping, the Chinese State Council’s Financial Stability and Development Committee (FSDC) announced several new measures to help calm markets, some of which hit what we think were the chief causes of the last year’s slide. Now, the last time they tried a large intervention, in January 2016, it seemingly had the opposite of its intended effect as Chinese stocks fell further.^[iii] Yet Wednesday, markets leapt, suggesting to us officials have learned from prior mistakes and seem aware of the issues impacting investors’ confidence.^[iv] Only time will tell if this recovery holds, but for now, the direct response to investors’ concerns is encouraging, in our view.

Technically, Chinese stocks are in a bear market. Their peak-to-trough decline breached -20% and, at over a year old, has proven lasting.^[v] But, in our view, its shape is more correction-like, as the decline occurred in a series of panicky plunges as investors reacted first to some regulatory changes, then defaults of distressed property developers, and now the latest COVID lockdown.^[vi] (Typically, bear markets are long, deep declines of -20% or worse, with fundamental causes, and our research finds they tend to begin gradually. Corrections are sharp, sentiment-fuelled declines of -10% to -20% and often feature steep declines early, according to our research.) Also more correction-like, in our view, sentiment seemed largely detached from reality throughout, with rumours and warnings from financial commentators we follow far exceeding the scope of the actual regulatory changes.^[vii] For instance, as we wrote last year, when Chinese officials disrupted private tutoring firms and jawboned about tightening the strings on giant Tech-like companies, investors responded with a big sell-off in the latter—even though actual measures taken ended up quite small and didn’t much disrupt earnings.^[viii] But the unpredictability and lack of transparency around the measures stoked many and varied warnings of worse to come from financial observers we follow.^[ix] Draconian policies didn’t follow, but we think the impact on sentiment was understandable.

Investors globally also faced questions about whether Chinese stocks would be investible.^[x] The US passed regulations that would force Chinese companies trading on US exchanges to delist in three years (unless they complied with auditing requirements, which would be illegal under Chinese law).^[xi] Meanwhile, when Didi, a large Chinese ride-sharing company, listed its shares on the New York Stock Exchange over the summer, the Chinese government cracked down, eventually forcing its move to Hong Kong—which is where other US-listed stocks are likely headed.^[xii] US investors can access Hong Kong markets pretty easily, and shares listed there trade easily and often. But the heated political rhetoric often drowned out that reality—just as hyperbolic headlines about Evergrande and other property developers’ defaulting often drowned out officials’ efforts to stabilise property markets and backstop healthy firms.^[xiii]

On Wednesday, the FSDC held a special meeting to address all of these concerns and released a statement of their high-level plans.^[xiv] On the delisting front, Chinese policymakers came out in support of letting mainland companies continue listing overseas, stating the US and China maintain a dialogue on this matter, have achieved progress and would unveil plans in due course.^[xv] Now, depending upon what the plan is exactly, Congress may have to repeal or amend the legislation in question (the Holding Foreign Companies Accountable Act), which China can’t control. But China’s apparent willingness to bend on audits is new—and seems like a positive step to us.

Elsewhere in the statement, officials said Tech regulation should be transparent, predictable and completed as soon as possible, indicating the associated uncertainty should end soon.^[xvi] They also reiterated their focus on managing risks in the property sector and announced plans to facilitate a new development model that wouldn’t rely on local government financing—another positive step, in our view.^[xvii] Lastly, they reiterated monetary and fiscal policy would remain accommodative, with an aim of keeping economic and loan growth steady.^[xviii]

This is vastly different from January 2016, when officials responded to sharp negativity by halting trading multiple times, blaming insiders’ sales and having the state buy stocks.^[xix] That seemingly gave global investors the perception something was fundamentally broken, requiring extra outside support—and stoking further volatility. This time, they appear to be taking a more technocratic approach and addressing investors’ concerns, and major institutions including the People’s Bank of China, finance ministry and securities regulators released quick statements of support.^[xx] It remains to be seen whether the impact will be lasting, or if Wednesday’s bounce is a one-off, yet we see the potential for these actions to materially improve sentiment toward Chinese stocks, should follow-through prove material. Notably, they follow what we have observed to be the standard Chinese policy blueprint: high-level statements setting out the overall policy direction, with the expectation of more specific measures to come. There also appears to be a great degree of coordination, suggesting top policymakers are increasingly aware of how last year’s uncertainty hit sentiment.

In a sense, this development isn’t a huge shock to us. This is China’s equivalent of an election year, and President Xi Jinping has reportedly been laying the groundwork for an unprecedented third term. Key to ensuring this? Probably a happy, prosperous citizenry, and the mainland’s stock market is increasingly important to this, in our view. We have long observed that Chinese policymakers tend to turn on fiscal and monetary stimulus to speed growth in election years, and helping the stock market recover seems like a natural extension of this.