“A white knuckle ride” is how Dzmitry Lipski, head of funds research at Interactive Investor, described the performance of the Chinese stock market in the wake of a government crackdown on the nation’s technology giants. The average China/Greater China fund is down 13% for the year to date after a tough and volatile time for investors.
Few would have predicted these problems at the start of the year. The Chinese economy was riding high – the only major economy to report growth in 2020. The Stock Connect programme, allowing links between Hong Kong and mainland investors, was creating liquidity and growth in the A Shares and H Shares markets. A rich IPO market was bringing exciting new companies to market and the long-term growth story, as hundreds of millions moved up the wealth scale, appeared firmly in tact.
The most recent problems have been caused by a government crackdown on the nation’s tech giants. Regulators blocked a merger between Douyu and Huya, two of China's biggest live-streaming video game sites. The government has also been dishing out hefty fines for anti-competitive behaviour. Ride hailing app Didi also came under fire after its New York listing: China suspended its app from the nation's mobile stores amid accusations of illegally collecting data from its users.
Fund managers have mixed views of this clampdown. Some point to the surprisingly lax regulation under which China’s technology giants had operated previously. However, it has undoubtedly been a reminder that the Chinese government does not want alternative centres of power and that it will act to retain control.
The regulatory tightening has not been confined to the technology sector. Policymakers also have the housing sector and private education in their sights. Ostensibly, they hope to improve support for the regime, but it has added to the unease felt by investors over the stability of the business environment in China.
A second problem has been that economic growth is weaker than expected. Retail sales, industrial production and fixed asset investment growth have all come in below expectations in recent months. Equally, having had a stronger year in 2020, China is not necessarily benefiting as strongly from the reflation trade.
The Chinese authorities are disinclined to pump prime the economy to the same extent that Western powers have done. They started to withdrew policy support early this year on the basis that China’s economy was recovering well and have not altered their view in the wake of weaker data or the (limited) revival of the Coronavirus. Policymakers may yet change their mind, particularly if global growth weakens and dampens Chinese growth.
Another factor has been valuations. While these are notably lower than there were just a few months ago, this should be set in the context of an average 33.5% rise for China funds in 2020. Valuations – particularly in the internet sector – had become stretched and a pullback may provide opportunities for investors.
However, investors still can’t ignore the long-term case for China. The move to a consumer-led economy has gone better than many economists initially predicted and an emerging middle class continues to power growth. There are moves by the government to keep more of this capital within China – promoting domestic tourism, for example, and building high quality local brands. This suggests that the quantum of Chinese growth may diminish, but the quality may improve.
There are other, technical factors for the Chinese economy. Investors are increasingly looking at single strategies in China, rather than holding it as part of a diversified emerging markets strategy. This, along with the successful Stock Connect programme, is likely to improve flows into Chinese markets. Equally, China continues to dominate the MSCI Emerging markets index, which means its markets are well-supported by passive flows.
Ultimately, in spite of its difficult politics, China offers growth in a growth-starved world. The markets are unquestionably volatile, particularly the A Shares market that has lots of retail participants. However, while there may be short-term problems, the long-term case for China is undoubtedly still in tact.