Chinese stocks have been melting down after the government has begun cracking down on big tech companies. Seeing share prices fall off a cliff is often a painful sight for investors. But is this a great time to buy? Or is it a value trap?

Let’s start by setting the scene. To operate in China, whether a company is private or public, it needs the government’s support to succeed. Investors might have overlooked this key factor as many appear to have assumed that the big Chinese stocks were under the same scrutiny as those listed in places like America. However, this all changed last year.

Going back to the beginning with Ant Group

In November 2020, Jack Ma (founder of Alibaba) attempted to launch a new financial technology business, Ant Group. There was so much hype around this chinese stock’s initial public offering (IPO) as it would be the largest one ever, with a $250 billion valuation! That’s even bigger than Saudi Aramco initial price tag when it went public. But then the hype came crashing down after the Chinese government suspended the IPO indefinitely. What happened?

At the Bund Summit – a financial conference – in Shanghai, Jack Ma spoke negatively about the financial regulators in Chinese markets. He said that they are only concerned with minimising risk, and this stops innovation in its tracks. He even stated that the lenders act like “pawnshops” by only lending to those with collateral. Needless to say, the government was less than pleased to hear that.

What’s happening today?

Fast forward seven months, and the onslaught continues. Recently China has been citing anti-monopoly legislation to go after large technology companies. These laws are in place to stop monopolistic behaviour within the economy and protect fair competition. 

Similar laws exist worldwide. But what people often forget is that while China may have adopted a capitalist economic system in recent years, it’s still very much a communist country. That means the government holds all the power in society, and the ideology is one of equality amongst its people. In other words, the larger a business gets relatively to others, the more likely the government will intervene. 

These interventions have resulted in numerous investigations and led chinese stocks like Alibaba to paying a whopping $2.8bn fine. DiDi is another example, except this time, their platform was outright banned from all app stores indefinitely, cutting future growth potential.

What has been the impact on Chinese stocks?

A good way to look at the impact on Chinese stocks is an index with Chinese stocks in it. The Nasdaq Golden Dragon China Index tracks 98 of the country’s biggest firms listed in the US.

Since February 2021, the index has dropped by 74%, and $769bn of value has been erased. Baron Rothschild is famous for saying, “Buy when there’s blood in the streets, even if the blood is your own”. And to many, this collapse in price may seem like a fantastic buying opportunity. But is it a good idea?

Should I buy Chinese stocks now that they’ve dropped?

Price is what you pay, and value is what you get. This is an adage of investing that is particularly true in reviewing Chinese stocks. Looking at the P/E ratios of the MSCI China index versus the MSCI World index, it’s possible to infer that Chinese stocks look cheap. But they’re cheap for a reason.

This is not the first time Chinese authorities have caused disruptions in the business world. And it certainly won’t be the last. I believe this risk factor needs to be considered before making any investment decision in this space. Here at The Money Cog, we always add a discount factor for companies operating in weaker economies or politically unstable countries that don’t offer democratic protections. 

With that in mind, I’m personally drawn towards the companies which are more likely to benefit from China’s new policies, such as EV stocks and renewable energy businesses.