Introduction
Plenty of us own equities in more than just one country. It’s an essential part of smart portfolio balancing.
But there are always interesting corners of the market we haven’t explored, and a lot of people speak about China being the kind of opportunity that doesn’t come along very often in investing.
Hundreds of companies are listed on the US market despite being based in China. This obviously can be complicated for regulation, and for transparency, but with exposure to the world’s second largest economy and some enormously impressive entrepreneurship despite the more restrictive policy, it might just be a risk worth taking.
The economy in China held up fairly well until the start of 2022, clearly looking to support business, but GDP has suffered a notable drawdown since, likely to experience a recession alongside the rest of the world sometime in 2023. (Source)
Sectors
So we know it’s a massive country, with a blossoming middle class, and expansive business mentality, but what sectors are companies in China focussing on?
The majority of these companies are internet-based commerce, but plenty incorporate a wide range of sectors within the one company, such as Tencent’s WeChat, which essentially includes everything you might need your phone for.
Other e-commerce companies are plentiful, each with solid fundamentals, and clear growth in the future if you can get past the prospect of further pressure on Chinese names in the US Market.
Some of my favourites include:
JD.com (JD)
Pinduoduo (PDD)
Tencent (TCEHY)
Vipshop (VIPS)
Tencent Music Entertainment (TME)
NetEase (NTES)
Trip.com (TCOM)
Dada Nexus (DADA)
Bilibili (BILI)
Joy (YY)
KE Holdings (BEKE)
China also has a huge emphasis on the expanding EV, Solar Energy, and for profit education, with companies such as:
BYD Co. (BYDDF)
Daqo New Energy (DQ)
JinkoSolar (JKS)
New Oriental Education (EDU)
TAL Education (TAL)
Gaotu Techedu (GOTU)
Government Restrictions
So what’s the catch? These companies all seem great!
In the last few years, Chinese tech companies have been under heavy scrutiny by the authorities, rapidly escalating their regulation, breaking up companies which are getting too large, and attempting to prevent antitrust and data protection issues.
Alibaba and Tencent alone have wiped billions off their market cap, with some uncertainty as to whether this will continue, with President Xi securing an unprecedented third term in office.
Such authoritarian control of public companies is obviously frowned upon by the US regulators, which has often raised the question of companies being delisted.
However, recent discussions have suggested some appetite for both sides agreeing to cooperate on inspecting auditory papers. This has taken the likelihood of delisting down to about 50% according to Goldman Sachs, down from a huge 95% in March of 2020. (Source)
Obviously if delisting became an imminent prospect, we’d see some serious damage to the stocks, but with the markets clearly pricing in some of this risk already, is that a potential opportunity?
GS analysts suggest a 13% drop in Chinese stocks may be possible if there are further deteriorations in the negotiations, but potentially an 11% rally if delisting became less of a threat.
Definitely something to consider…
Taiwan
The Chinese authorities still consider Taiwan part of its sovereign territory, where Taiwan considers itself as a distinct entity.
This has led to major geopolitical tensions, where the US and others reserve the right to defend Taiwan if China chose to invade. China has also suggested it would not rule out military force if required, but recent events in Ukraine may cause Xi to think twice about any military solutions in the near term.
Lockdowns
The more immediately concerning and impactful variable for stocks with exposure to China has been the ‘Covid-zero’ policy.
Since emerging in Wuhan in 2020, China has had a radical approach to the spread of Covid-19, locking down entire towns or cities.
With much more authority to limit the freedom of citizens, this has largely been adhered to, but two years on, China continues its aggressive stance towards even minor outbreaks of the virus.
In the last month, we saw extensive lockdowns in Apple’s Foxconn plant, the world’s largest factory. (Source)
If this policy remains in place, further pressure will likely be felt by Chinese stocks, but with rumours of lightening isolation periods, this could be on the verge of turning around, presenting further opportunities for such stocks. (Source)
Is it Worth it?
So obviously the China focussed US companies are a complicated bunch, with regional, national and international variables to consider. But with so many companies operating internationally, I’d go as far to say a good amount of the market is linked to how China operates, with Apple, Tesla, Starbucks and more all feeling the impact of lockdowns, regulation and geopolitics.
I see some real opportunities in some of these companies, and want to have exposure to a market which clearly has potential, despite current economic difficulties.
The level to which you commit will be dependent on your appetite to risk, opinion on these important geopolitical and economic issues, and your investment horizon.
Note- I currently own positions in Alibaba and Tencent.
Disclaimer- Investments can fall and rise. Capital at risk. Any information in this post should not be construed as investment advice.
Good write up Gordon. What’s your favourite Chinese company?