In this article, we will look at the future of China's concept stocks and see whether they will present opportunities or risks.
1. Opportunities for China concepts stocks
In a narrow sense, China's concept stocks generally refer to a set of stocks of Chinese companies that are listed in the United States. However, in a broader sense, any stock of a listed Chinese company, be it a US stock, Hong Kong stock, or even A shares in China, can be considered as the China concept stock.
Aside from short-term fluctuations, from a long-term perspective, the investment opportunities for China concepts stocks mainly lie in the following three areas.
Firstly, China's economy is growing, and the country has seen a rise in high-quality companies.
When we buy a stock, we are investing in a company. And the soil from which the company can flourish comes from the country it is in. If the country is developing quickly, it would be easy for the company to ride the wave and grow. To a great extent, Warren Buffet's impressive investment track record was because the US economy boomed for most of his investing career.
Over the last few decades, China's economy has grown rapidly, resulting in the emergence of many high-quality companies. Even in the face of the COVID-19 pandemic, China managed to leverage its enormous domestic market to steady the ship and develop its manufacturing capacity across all product categories. China remains the economy with the most stable growth and robust economic vitality globally.
Suppose we use the US stock market as a benchmark. In that case, China has the potential to create a large number of excellent companies in fields such as mass consumption, medical care, emerging technologies, and innovations, and whose stocks will remain bullish over a long time.
Secondly, more capital is being injected, which will result in greater liquidity in China's concept stocks.
In terms of domestic capital, with the shifting of the people's wealth, China concept stocks may see more capital injection and liquidity.
In the past, with the perception that property prices would keep rising, the wealth of the Chinese people was tied up in the property market. A lot of people bought houses when they had the money. The property market attracted most of the capital, and very limited funds flowed into the stock market. With greater policy control, speculative property investments have been curbed to a certain extent in recent years. The lure of the property market has weakened, and some of the money may start shifting out from the property market to the stock market.
In addition, in recent years, the idle funds of the Chinese people have also started to gradually move from savings and wealth management to the securities market. Such a shift will bring more capital to China's concept stocks.
In terms of foreign capital, although the amount of foreign investments in China concept stocks may continue to fluctuate in the short term due to policies and market conditions, it should continue to increase over a longer horizon, and there is still a lot of room for growth.
Foreign investors can freely invest in China's concept stocks that are listed in Hong Kong or the US, but there are certain restrictions on A-shares. In recent years, nearly RMB 3 trillion worth of A-shares have been bought by foreign investors through channels such as Shanghai and Shenzhen Stock Connect, QFII, and RQFII. Out of which, over RMB 2.5 trillion worth of shares were held by Shanghai and Shenzhen Stock Connect, which is three times higher than in 2018 but merely 3% of the total market value of A-shares. This proportion is far lower than that of foreign shareholding in most emerging markets. As China's capital market continues to open up, foreign investors may continue to increase their investments in Chinese assets and bring more liquidity to China's concept stocks.
The liquidity of funds largely influences the development of a stock market. With more domestic and foreign capital injections, China's concept stocks will find more opportunities.
Thirdly, following a deep correction, the price of China's concept stocks is relatively low.
From February 2021 to March 2022, China's concept stocks experienced a historical decline that lasted for 13 months. In total, China's concept stocks in US exchanges lost up to 75% of their value. Hong Kong's Hang Seng Index fell by 45%, the Hang Seng Technology Index fell by nearly 70%, and the A-Share Shanghai Stock Exchange Index dropped by nearly 20%, marking a rare phenomenon in history in terms of both the duration of the downtrend and the magnitude of the drop.
With this round of decline, the overall value of China concepts stocks has hit historic lows.
In terms of data, as many technology companies with high growth but have yet to become profitable were listed in the US and Hong Kong stock markets over the last two years, the price-earnings ratio offers little insight. Therefore, we will use the price-to-book (PB) as the gauge.
After experiencing this round of prolonged deep correction, the PB ratio of China concepts stocks has almost fallen to its historical low. For example, the China Securities 500 Index, which is a good reflection of the performance of A-shares, is now cheaper than 95% of the time in its history. Hong Kong's Hang Seng Technology Index is now cheaper than 96.8% of the time in its history, and the BITA China Internet Giants Index is now cheaper than 99.5% of the time in its history.
In contrast, the current PB ratio of the S&P 500 and Nasdaq 100, which may represent US stock markets, is now more expensive than 90% of the time in their history.
A rising market brings risks, while a falling market brings opportunities. After a prolonged uptrend, the valuation of the US stock market is relatively high and to the point where investors should start taking measures to mitigate risks. In contrast, after a historical decline, the valuation of China's concept stocks is relatively low, which means they can deliver more opportunities.
2. Risks of China concepts stocks
All investments carry some degree of risk. Stocks that can offer potentially high returns also have more considerable risks. For China concept stocks, the risks come from two main areas.
The first is systemic policy risks.
Earlier, the US Securities and Exchange Commission (SEC) required US-listed China concept stocks to provide their audit papers. If a company fails to do so for three consecutive years, the SEC has the right to delist the China concepts stock. Chinese regulators believe this poses a risk of a potential data leak. This disagreement between the regulatory bodies may see some China concept stocks face the threat of being delisted. As a result, their prices may drop significantly, which may also drag China concepts stocks on the Hong Kong Stock Exchange and other A shares down.
The second is industry policy risks.
Over the past year, some of the industries that the China Concepts stocks are in suffered different policy risks. For example, some large internet platform companies were impacted by anti-monopoly measures, and some companies in the education and training industry were forced to close shop due to policy changes. Moreover, the market is concerned that other industries may suffer from a similar fate in the future. As a result, not only did the share prices of the companies impacted by new policies drop, but the prices of unaffected China concepts stocks declined.
Based on the efficient-market hypothesis, share prices will reflect all risks. These systemic policies and industry policy risks caused the prices of China's concept stocks to experience a prolonged period of steep decline. However, following the drastic correction, most related risks have already been released from the China concepts stocks.
In addition, the Chinese government gave a positive signal for both these issues during its financial meeting in mid-March.
On the one hand, the government said during the meeting that the regulatory bodies in China and the US have maintained good communication and have been working together proactively on the issue of China concept stocks. Both parties are currently drafting a specific cooperation plan, which would relieve some of the systemic policy risks of China's concept stocks. On the other hand, the Chinese government emphasized during the meeting that the related department should be prudent when introducing contractionary policies. Any policy that may cause a significant impact on the capital market must first be discussed with the finance authorities to ensure stability and consistency in the expectations of the policies. That also dispels some of the industry policy risks that the market is concerned about.
Overall, the risks of China's concept stocks persist, and market concerns have yet to recede. In the short term, there is still significant uncertainty. However, in the long run, buying stock to buy in a company and its development largely depends on the prosperity of the country it is in. A booming economy like China provides the best soil for the survival and growth of outstanding companies, including those involved in China's concept stocks. At the same time, with the injection of more and more capital, China concept stocks will have higher liquidity. Driven by internal growth and capital injection, the extremely low prices of some of these China concept stocks may recover back to a reasonable valuation, delivering long-term returns to investors in the process.