Some Chinese Stocks Are Starting to Look Like Bargains
Investing in China is becoming increasingly difficult. Here’s where to look.
Investing in China is becoming increasingly difficult. Here’s where to look.
Investing in China is even trickier than usual these days, leading some to wonder if it’s worth the trouble. And it’s not likely to get easier in the near term, though volatility over the next couple of months could create bargains for long-term investors.
Since scuttling the anticipated public offering of Ant Group last fall, Chinese regulators have been targeting the country’s biggest and most widely held internet companies. On July 2, Beijing struck again, launching a cybersecurity review of DiDi Global (ticker: DIDI) and ordering its app to be pulled from mobile stores, as it tightened controls over data security and rules for companies listed overseas.
The move, just days after DiDi had raised $4.4 billion in the year’s biggest IPO, led the stock to lose a fifth of its value on July 6, and rattled other Chinese internet shares. The KraneShares CSI China Internet exchange-traded fund (KWEB) has fallen 15% since June 30, as investors braced for more scrutiny of tech companies’ data practices and other regulatory moves.
“We now know this is a regulatory minefield, and those who expose themselves to the sector are taking on a lot of volatility,” says Arthur Kroeber, Gavekal Research’s head of research. “If your horizon is long term, this is going to be one of the growth stories of the next decade and you have to ride it out. But if you are more short term, you may say it’s too complicated and come back in a year when things have calmed down.”
The wave of regulatory measures has created the type of uncertainty that draws bargain hunters. Technology giants like Alibaba Group Holding (BABA), whose shares are down 11% this year, are popping up on value managers’ radars. But caution is warranted, especially for investors in U.S.-listed shares of Chinese companies. Regulatory pressures could continue. “It’s probably just the start of the enforcement actions,” says Kenneth Zhou, a partner at law firm WilmerHale in Beijing.
Fund managers have described China’s regulatory drive as a move to gain better control and set up guardrails for fast-growing digital industries and internet titans. It’s also a way for Beijing to deal with escalating U.S.-China tensions, in part resulting from recent legislation in Washington that sets the stage for delisting Chinese companies if they don’t offer more auditing disclosures within three years.
One concern for China’s regulators: the valuable troves of data collected by Chinese tech companies listed in the U.S., creating a possible national security threat.
“Control of data is shaping up to be a major domestic and geopolitical issue, with direct equity market implications for firms operating on both sides of the Pacific,” Rory Green, head of China and Asia research at TS Lombard, said in a recent research note.
Beijing is trying to gain better control of Chinese companies, including those listed abroad. Many of the largest Chinese techs, like Alibaba, Tencent Holdings (700.Hong Kong) and JD.com (JD), are registered in the Cayman Islands and use a variable interest entity (VIE) structure, allowing them to get around Chinese restrictions on foreign ownership. Though largely ignored by investors, the complex structure is a gray area because, under it, foreigners don’t actually own a stake in a Chinese company. Instead, they must rely on China honoring contracts that tie them to the company.
For decades, China has largely turned a blind eye to the extralegal structure, but it’s paying more attention now. Bloomberg News reported this past week that Beijing is considering requiring companies that use this structure to seek its approval before listing elsewhere. Already-listed companies might have to seek approval for any secondary offerings.
Analysts and money managers say they don’t expect China to unravel the VIEs, which are used by the country’s largest and most successful companies and would take decades to undo. Many are also skeptical that the U.S. will follow through with its delisting threat.
But Beijing could use VIE scrutiny to exert increased control over companies and to push back against U.S. regulators’ calls for more disclosure. Indirectly, the scrutiny will likely bolster Beijing’s efforts to lure domestic companies back home—a drive that’s already led to secondary listings in Hong Kong for Alibaba, Yum China Holdings (YUMC), and JD.com.
Analysts also expect the heightened scrutiny to slow, if not halt, the number of Chinese companies coming public in the U.S. in the near term. It could also shrink the tally of U.S.-listed Chinese companies—more than 240 with over $2 trillion in combined market value—that appeal to do-it-yourself retail investors. Any of these unable to secure secondary listings in Hong Kong or China might go private, says Louis Lau, manager of the Brandes Emerging Markets Value fund.
U.S.-listed stocks could see volatility as a result. Increasingly, fund managers and institutional investors—Lau included—have been gravitating toward stocks listed in Hong Kong or mainland China whenever possible. For retail investors, the best way to access these foreign listings, as well as the more domestically oriented stocks that some fund managers favor, is through mutual or exchange-traded funds.
Money managers are better positioned to navigate some of the logistical complications created by U.S.-China tensions, such as the fallout from a recent executive order that banned U.S. investment in companies that Washington says has ties to China’s military complex. The S&P Dow Jones Indices and FTSE Russell decided this month to boot more than 20 Shanghai- and Shenzhen-listed concerns affected by the order.
Other companies could also be banned and face similar fallout, with Reuters reporting on July 9 that the Biden administration is considering adding more Chinese entities to the banned list over alleged human rights abuses in Xinjiang.
As investing in China gets more complicated, the case builds for investors to choose a fund manager who can navigate these complexities and invest locally. Failure to do so could be costly. The iShares MSCI China A ETF (CNYA) is up 3% over the past three months, while the Invesco Golden Dragon China ETF (PGJ), which focuses on U.S.-listed Chinese companies, is down 14% in the same span.
“Regulation is here to stay. Investors will just have to get used to this,” says Tiffany Hsiao, a veteran China investor who is a portfolio manager on Artisan’s China Post-Venture strategy. “This is capitalism with Chinese characteristics. China is obviously still a Communist state. It embraces capitalism to drive innovation and improve productivity, but it’s important for companies that do very well to give back to society—and Chinese regulators will remind you of that.”
As a result, she says, investors must move beyond the widely held internet titans to find stocks that could benefit from the regulatory scrutiny that the giants face. Veteran investors are stressing selectivity, searching in local markets for companies that are outside the crossfire.
“A company can have great fundamentals and interesting opportunities, but get blindsided by government action, which is increasingly active,” says David Semple, manager of the VanEck Emerging Markets fund (GBFAX). “You need a higher degree of conviction than normal to be involved.”
Semple is gravitating toward companies he’s familiar with, in sectors that could get hit by regulation, but with less impact than investors think.
One example: China is targeting after-school course providers, as it tries to lower child-care costs and encourage families to have more children. Nonetheless, Semple sees opportunity in China Education Group Holdings (839.Hong Kong), which could make acquisitions as Beijing forces public universities to divest affiliated private ones.
Of the large internet stocks, Semple favors Tencent, the top position in his fund, over Alibaba, another holding. Alibaba faces more competitive pressures, Semple says, and Tencent has an advantage with its Weixin messaging and videogaming franchises, which provide a high-quality, relatively low-cost flow of users for its other businesses.
Tencent also has quietly complied with the government’s requirements, with CEO Ma Huateng keeping a low profile, says Martin Lau, managing partner and a portfolio manager at FSSA Investment Managers, which oversees $37 billion. That’s a positive, given the backlash that met outspoken Alibaba and Ant co-founder Jack Ma.
Many Chinese internet companies’ fundamentals are sound. However, complying with the stringent rules on collecting and safeguarding user data probably will reduce their profits from that area, says Xiaohua Xu, a senior analyst at Eastspring Investments.
Alibaba and other internet companies, including JD.com, are cheap enough to attract value investors. But volatility is likely, with investors recalibrating growth expectations as Beijing rolls out new rules, and reviews past deals. In addition, widely held U.S.-listed Chinese stocks, including Alibaba, could become proxies for investors’ China angst.
Despite the yellow flags, investors have reason to keep China in the mix. “If you are buying growth, the world has twin engines: the U.S. and China,” says Jason Hsu, chairman and chief investment officer of asset manager Rayliant Global Advisors and co-founder of Research Affiliates. But, he adds, the U.S. is more expensive. “And whenever there is risk—and the world sees China as risky, with this deepening that bias—that means opportunity.”
Reprinted by permission of Barron’s. Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: July 12, 2021.
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Food prices continue to rise at a rapid pace, surprising central banks and pressuring debt-laden governments
LONDON—Fresh out of an energy crisis, Europeans are facing a food-price explosion that is changing diets and forcing consumers across the region to tighten their belts—literally.
This is happening even though inflation as a whole is falling thanks to lower energy prices, presenting a new policy challenge for governments that deployed billions in aid last year to keep businesses and households afloat through the worst energy crisis in decades.
New data on Wednesday showed inflation in the U.K. fell sharply in April as energy prices cooled, following a similar pattern around Europe and in the U.S. But food prices were 19.3% higher than a year earlier.
The continued surge in food prices has caught central bankers off guard and pressured governments that are still reeling from the cost of last year’s emergency support to come to the rescue. And it is pressuring household budgets that are also under strain from rising borrowing costs.
In France, households have cut their food purchases by more than 10% since the invasion of Ukraine, while their purchases of energy have fallen by 4.8%.
In Germany, sales of food fell 1.1% in March from the previous month, and were down 10.3% from a year earlier, the largest drop since records began in 1994. According to the Federal Information Centre for Agriculture, meat consumption was lower in 2022 than at any time since records began in 1989, although it said that might partly reflect a continuing shift toward more plant-based diets.
Food retailers’ profit margins have contracted because they can’t pass on the entire price increases from their suppliers to their customers. Markus Mosa, chief executive of the Edeka supermarket chain, told German media that the company had stopped ordering products from several large suppliers because of rocketing prices.
A survey by the U.K.’s statistics agency earlier this month found that almost three-fifths of the poorest 20% of households were cutting back on food purchases.
“This is an access problem,” said Ludovic Subran, chief economist at insurer Allianz, who previously worked at the United Nations World Food Program. “Total food production has not plummeted. This is an entitlement crisis.”
Food accounts for a much larger share of consumer spending than energy, so a smaller rise in prices has a greater impact on budgets. The U.K.’s Resolution Foundation estimates that by the summer, the cumulative rise in food bills since 2020 will have amounted to 28 billion pounds, equivalent to $34.76 billion, outstripping the rise in energy bills, estimated at £25 billion.
“The cost of living crisis isn’t ending, it is just entering a new phase,” Torsten Bell, the research group’s chief executive, wrote in a recent report.
Food isn’t the only driver of inflation. In the U.K., the core rate of inflation—which excludes food and energy—rose to 6.8% in April from 6.2% in March, its highest level since 1992. Core inflation was close to its record high in the eurozone during the same month.
Still, Bank of England Gov. Andrew Bailey told lawmakers Tuesday that food prices now constitute a “fourth shock” to inflation after the bottlenecks that jammed supply chains during the Covid-19 pandemic, the rise in energy prices that accompanied Russia’s invasion of Ukraine, and surprisingly tight labor markets.
Europe’s governments spent heavily on supporting households as energy prices soared. Now they have less room to borrow given the surge in debt since the pandemic struck in 2020.
Some governments—including those of Italy, Spain and Portugal—have cut sales taxes on food products to ease the burden on consumers. Others are leaning on food retailers to keep their prices in check. In March, the French government negotiated an agreement with leading retailers to refrain from price rises if it is possible to do so.
Retailers have also come under scrutiny in Ireland and a number of other European countries. In the U.K., lawmakers have launched an investigation into the entire food supply chain “from farm to fork.”
“Yesterday I had the food producers into Downing Street, and we’ve also been talking to the supermarkets, to the farmers, looking at every element of the supply chain and what we can do to pass on some of the reduction in costs that are coming through to consumers as fast as possible,” U.K. Treasury Chief Jeremy Hunt said during The Wall Street Journal’s CEO Council Summit in London.
The government’s Competition and Markets Authority last week said it would take a closer look at retailers.
“Given ongoing concerns about high prices, we are stepping up our work in the grocery sector to help ensure competition is working well,” said Sarah Cardell, who heads the CMA.
Some economists expect that added scrutiny to yield concrete results, assuming retailers won’t want to tarnish their image and will lean on their suppliers to keep prices down.
“With supermarkets now more heavily under the political spotlight, we think it more likely that price momentum in the food basket slows,” said Sanjay Raja, an economist at Deutsche Bank.
It isn’t entirely clear why food prices have risen so fast for so long. In world commodity markets, which set the prices received by farmers, food prices have been falling since April 2022. But raw commodity costs are just one part of the final price. Consumers are also paying for processing, packaging, transport and distribution, and the size of the gap between the farm and the dining table is unusually wide.
The BOE’s Bailey thinks one reason for the bank having misjudged food prices is that food producers entered into longer-term but relatively expensive contracts with fertilizer, energy and other suppliers around the time of Russia’s invasion of Ukraine in their eagerness to guarantee availability at a time of uncertainty.
But as the pressures being placed on retailers suggest, some policy makers suspect that an increase in profit margins may also have played a role. Speaking to lawmakers, Bailey was wary of placing any blame on food suppliers.
“It’s a story about rebuilding margins that were squeezed in the early part of last year,” he said.
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