- 5-year plan identifies key areas that strengthen regulation and leave room for wide interpretation.
- Tech and data companies are a focal point, yet even banking and insurance already felt the pinch.
- Opportunities likely exist in companies already fined like Alibaba
- Despite the crackdown, investors flocked to Chinese funds last month
- Make sure you evaluate the risks of individual companies and ETFs alike.
China does not run a free economy.
You need look no further than their 5-year plan’s document.
Investors scoured the text to validate or refute their positions.
While much of it repeated what most of us already knew, there are several key insights we can glean.
Document Highlights
Here are the main points you need to be aware of:
- Vigorously promote “one thing once”….optimize the integration and upgrade the “one-stop” function of government affairs halls at all levels
- “Actively promote legislation” in areas such as national security, technological innovation, public health, culture and education, ethnic religion, biosecurity, ecological civilization, risk prevention, anti-monopoly, and foreign-related issues
- Strengthen the regulation of common administrative acts and legislation, and promote the legalization of institutions, functions, powers, procedures, and responsibilities
- “Intensify law enforcement in key areas related to the vital interests of the people” including food and medicine, public health, natural resources, ecological environment, safety production, labor security, urban management, transportation, financial services, education and training.
- Ensure “healthy development of new business forms” with “good laws and good governance” related to digital economy, Internet finance, artificial intelligence, big data, cloud computing and other related legal systems
- Strengthen the execution of administrative decision-making: “Once a major administrative decision has been made, it shall not be arbitrarily changed or suspended without legal procedures.”
- Use the internet and big data in law enforcement: “Strengthen the construction of the national ‘Internet + supervision’ system, and realize the integration and aggregation of data from supervision platforms by the end of 2022.”
In a nutshell, the document gives us a timeline and breadth for the regulatory crackdown.
Based on the framework, we can expect the government to take a heavy-handed approach to any and all technology companies, especially those handling data.
Even those not mentioned directly in the document faced tighter regulations.
According to Bloomberg News, China’s banking and insurance watchdog ordered companies and local agencies to curb improper marketing and pricing practices, and step up user privacy protection.
What this means for outside investors
The cloud of uncertainty hanging over Chinese companies thickened dramatically.
Both the broad language and the liberal interpretation taken by regulators to date demonstrate a willingness to control every aspect of the economy.
It also forecasts further problems for Hong Kong.
A face value reading of the text suggests China’s central government plans to flex its authority to bring economic and political reform to the city.
Given that most of the large companies we trade, such as Alibaba (BABA), have their primary listing on the Hang Seng Hong Kong Exchange, American investors, in particular, face greater individual equity risks.
Yet, so far, investors aren’t particularly worried if you look at ETF fund flows.
Because from July 1st until yesterday, KraneShares CSI China Internet ETF KWEB was the #8 ETF for inflows!
In the last two weeks of July, fund focused Chinese stocks saw $3.6 billion in inflows, 10x more than their U.S. counterparts.
Where there is opportunity
Alibaba was already forced to pay a $2.8 billion fine, one of the largest in history.
It’s less likely the government goes back for second helpings anytime soon.
That allows Alibaba’s three main operations, Alibaba.com, TaoBao, and Tmall relatively free to grow organically.
Instead, growth through acquisitions will decline amongst target companies, while it could thrive in industries with heavier government control like infrastructure.
Our hot take
No doubt there is value in Chinese equities which always carried political risk. We saw that reflected in the lower premiums in Chinese listed stocks relative to similar U.S. counterparts.
What we don’t know is the size of that risk on an individual company level or even at a sector level.
And the scary part is the money flowing into China.
We think the heavy inflows into Chinese funds are caused more by bargain hunting and overall investor euphoria than true value investing.
In fact, it’s more likely that those buying into the names now don’t truly appreciate or know how to assess the risks properly.
That’s why both traders and investors need to understand the individual companies and the ETFs.
For example, KWEB focuses on stocks listed on the Shanghai Exchange while iShares China Large-Cap FXI invests in companies listed on the Hong Kong Exchange.
Keep in mind that there are plenty of ETFs out there that deal with Asia or emerging markets without China.