Beijing's crackdown hangs over China markets, but some stocks may be getting less risky

Published Mon, Aug 9 202111:39 AM EDTUpdated Mon, Aug 9 202112:40 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Some beaten-down Chinese stocks may be safer bets than others, as Beijing imposes new regulatory restrictions on internet companies and other industries. China's snowballing crackdown is not likely to end soon, and more industries could be swept up in the government's efforts to reform the relationship between public companies and the state. "In terms of investing in them, the backdrop obviously is starting … last year, when Jack Ma criticized the Chinese government . China, I think, at that point decided enough is enough, and they stepped in and blocked the Ant Financial IPO," said Dan Niles, founder of Satori Fund. "People took that as a once off." But instead, the government has been increasing the pressure. Beijing ordered Ant Group to restructure its business . Its sister company Alibaba was fined $2.8 billion in April for violating anti-monopoly regulations. David Bianco, CIO Americas at DWS Group, said China is too important a market to stay away from, even with the crackdown. "We're not abandoning the tech titans out of China. We're sticking with them," he said, noting that he is also cautious. "It's a risk that isn't 100% priced in, but I think it's one that is significantly priced in and more than appropriately reflected. We're nibbling on these." Bianco sees some opportunities among big tech names, as China stresses that it wants to be dominant in all aspects of technology. "I'm not promising a bottom on this one. I'm not saying back up the truck. We see it as high quality underlying businesses," he said. Of course, investors are also monitoring the risks from the pandemic. China's stock markets were higher Monday, even as Beijing tightened travel restrictions in response to the spreading coronavirus delta variant. The oil market reacted negatively to that report and also a sharp drop in demand for oil in China in July. Shanghai stocks were up 1% and Hong Kong rose 0.4%. Crackdown continuing Macquarie Capital economist Larry Hu said the government's regulatory drive will continue, but it has toned down its rhetoric and sounds a bit less hawkish. "For instance, for the first time, the Politburo meeting last [December] mentioned 'anti-monopoly' and 'curbing the disorderly expansion by capital,' portending a regulatory storm which would crush China's tech stocks in the coming months," he wrote in a note. "The latest Politburo meeting held on July 30, however, noticeably toned down the words on regulation," said Hu. "It doesn't mean that the regulation storm is over, but it does to a large extent curtail the political risk." China has warned companies against overseas IPOs. In July, ride-hailing company Didi Global became the target of government investigations shortly after it went public in New York. Expectations for other overseas IPOs came to a halt. I still think it's too early to catch a falling knife. Let the dust settle. To me, what I'm watching is what will be the penalty on Didi. chief investment officer at Rockefeller Global Family Office Jimmy Chang ByteDance, the owner of the popular TikTok social media video app, is making plans to go public on the Hong Kong Stock Exchange in September, after withdrawing from an overseas offering, according to a report in the Financial Times. The company has been focused on satisfying China's security concerns, including how it manages consumer information. The government turned up the heat more broadly in July when it issued new rules on how publicly traded education companies can operate and how they can raise money. On Monday, a state media commentary focused on regulators' concerns about speculators in the chip market, according to Bloomberg . On the Hong Kong Stock Exchange, shares of Semiconductor Manufacturing International Corp were 5% lower and Hua Hong Semiconductor shares were 5.7% lower. Gaming has also been under scrutiny. Last week, state media criticized online gaming , calling it "opium" in an article that was later pulled. That hit Tencent stock hard on concerns it could face tighter regulatory restrictions, and the company quickly announced new rules on how long minors can play online games. Beijing has also announced new regulations on food delivery, which hit the stock of online shopping platform Meituan. "The government is going after the socialism over shareholders policy. They're trying to do things to the benefit of the overall 90% of the population that doesn't own stock. If an industry hasn't been in the crosshairs, you have to be concerned," Niles said in an interview last week. "I think it depends industry by industry," he said. "We own a basket of over 50 internet names that we started to get into last Wednesday. We spread it out. You don't want to be in the one name they're going after." How to invest Niles said investors may want to look at companies that were already under fire and have taken steps to resolve concerns. "In 2018, they locked down approving new video games for 10 months, so certain parts of the Chinese internet industry have already gone through this," said Niles. Recently, Alibaba's stock did not fall that much even though its earnings report missed the mark when it reported in July, with revenue coming in below expectations. The stock was trading lower Monday after the company fired a manager in China who was accused of sexual assault and disciplined others as it sought to limit its reputational damage. Alibaba's stock is above its recent low of $179.67, but at about $194, it is well off its 52-week high of $319.32 in U.S. trading. Niles said it was encouraging that Chinese regulators have met with global banks. He said it's important to watch the behavior of government officials, but also the trading action in individual stock names for signs of a bottom. Tencent Holdings was about 4% higher Monday, after gains in Chinese markets overnight. KWEB, the KraneShares CSI China Internet ETF, was about 3% higher Monday. "Tencent and Alibaba are 25% of the Chinese ETFs. I wouldn't consider it a washout. They've been pretty beaten up. We do think a good amount of additional risk has been priced into these stocks, in terms of profit capping, profit redirection, ownership restructuring," Bianco said. The iShares MSCI China ETF and iShares China Large-Cap ETF have come off their recent lows and were higher Monday. Jimmy Chang, chief investment officer at Rockefeller Global Family Office, said he still believes it's too early to get into some of the beaten-down names, but he said there could be "fallen angels" to consider among some of the first sectors and companies hit by the government crackdown. Analysts say the health care and housing may be among the next sectors under increased scrutiny, so stocks in those areas could be at risk. They point out that the government had indicated housing should not be a target of speculators. "I still think it's too early to catch a falling knife. Let the dust settle. To me, what I'm watching is what will be the penalty on Didi," Chang said. "If the penalty is not as draconian as expected, meaning if the penalty does not harm the company's longer term prospects, that will be a positive signal." Bigger picture, China watchers say the government's actions could affect future growth if it restricts companies too much. "Alibaba and Tencent were the big drivers of productivity growth over the past few years," said Capital Group chief Asia economist Mark Williams. "If you kill the companies that are generating productivity growth, you have to accept that growth will slow in the future." Williams said the operating environment for companies in China has changed. "A Chinese company is free wheeling and trying to press the limits," he said. "But now they know things have changed, and they have to do what the party wants them to do. If you're unhappy in the U.S., you send a lobbyist to Washington, and if you're Tencent, you say, 'I'll do whatever you want.'"

The Chinese and Hong Kong flags flutter outside the Exchange Square complex in Hong Kong on Feb. 16, 2021.

Zhang Wei | China News Service via Getty Images

Some beaten-down Chinese stocks may be safer bets than others, as Beijing imposes new regulatory restrictions on internet companies and other industries.