After months of calling a market top in Chinese equities, large stocks have officially entered correction territory. The CSI 300 index, which tracks the largest companies traded in Shanghai and Shenzhen, is down 15 per cent from last month’s high. Tech stocks have led the fall.
There are three main reasons. First, US regulators have revived threats to delist Chinese companies quoted in the US. Second, Beijing is cracking down on the most lucrative units of its biggest tech groups, including Alibaba and Tencent. Third, investors fear monetary tightening. Officials are stressing the need for policies to reduce financial risks as well as support growth.
The drop in shares of tech groups including Baidu, JD.com and NetEase was an accident waiting to happen. Investors were optimistically betting US president Joe Biden would take a softer stance towards China than Donald Trump. Those wagers are unwinding. Chinese companies face losing their US listings unless they can prove a foreign government entity does not control them. They would also need to show that they follow US audit standards.
Delistings are now inevitable. Many US-quoted Chinese companies would have trouble complying with US audit requirements without violating Chinese laws. Their unwillingness to give foreign regulators full access to their books is unlikely to change. In the near term, Chinese companies that hold the largest market share of their respective industries are likely to run into further antitrust controls at home.
So far, declines are manageable. The CSI 300 racked up gains of almost 60 per cent in the 12 months before February’s reversal. Investor sentiment seems only slightly dented, with no signs of panic selling.
Valuations support that confidence. Even after recent declines, the CSI 300 trades at 16.8 times expected earnings for the next 12 months, a 40 per cent discount to the Nasdaq 100 and lower than the 22 times for the S&P 500. The steep tech valuations of local groups including Tencent and Xiaomi have been justified: they reported results this week that beat expectations.
US investors would be the biggest victims of the clampdown. Their delisted shares would theoretically still trade over the counter. But the new rules may prohibit US investment in any form. Chinese companies have strong growth prospects, provided they can avoid local antitrust action. Americans would miss out on a slice of this growth and with it diversification from their overheated domestic market.
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