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Flash Crash in US-listed Chinese Companies Explained

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Yesterday’s flash crash in US-listed Chinese companies has more than one culprit. Market structure is one issue as market makers are no longer required to make a two-way market, so stocks have gone down in the absence of buyers. The big culprit was a Reuters article with the great headline of “US SEC begins rollout of law aimed at delisting Chinese firms.” Supercomputers are coded to “read” headlines and trade on them. Yes, the SEC started the process of identifying the companies that the Holding Foreign Companies Act would affect as by law they are required to do so within 90 days. The process to identify the companies could take some time. Can you hear the can being kicked down the road?

There is speculation that this process could push the date for implementing the law to next year. Ultimately, do you think the SEC wants to hurt US investors? I don’t. US-listed Chinese companies will have to disclose if the government owns a piece of them if board members/executives are part of the Chinese Communist Party. Companies will disclose if they are compliant with the law. Doesn’t sound like a big deal to me, especially for the non-SOE companies. US exchanges will do their best to convince the companies to comply. If the companies don’t want to comply, investors will simply gravitate to the Hong Kong share classes, which would be a shame. 

The Reuters’ clickbait headline threw gasoline on what was already a down day. Bloomberg had an article that the PBOC was going to supervise the use of personal data from internet companies. This article has been requoted/republished by other media outlets, but I’ve not seen this substantiated anywhere else. This article seems to be taken as gospel though I can’t find anything else that supports it! What I have seen is that many apps require users' consent to use all personal data in order to use the app. This will go away as information not pertinent to the app usage won’t be allowed. This was announced Monday by the internet regulator. Chinese regulation came up during Tencent’s investor call. President Martin Lau very clearly stated that the company was complying with fintech regulations such as max loan size of 200k, holding 30% of loans, and not lending to college students. Markets are very concerned that anti-monopoly laws could force Tencent to divest from Tencent Music Entertainment and Baidu from iQiyi.

Vipshop has been rumored to be a Tencent acquisition target. These stocks fell 20% despite nothing in the anti-monopoly law that says the big companies can’t have stakes in other companies. Shoot first, ask questions later. The specter of more regulation is an overhang on the space as anti-competitive practices are going away while personal data needs to be addressed. The digital renminbi should help with the personal data issue, which is coming likely later this year. China is ahead of the curve on these issues, which I suspect will occur here in the US at some point. A fantastic movie on this topic is The Social Dilemma, which I highly recommend. 

Lastly, we are experiencing a rotation from work from home to reopening trades globally as the vaccine rollouts. The WFH stocks have had a tremendous run, so we are seeing some profit-taking. As we conclude Q4 2020 earnings for the Chinese internet space, they have been largely strong. Remember that Q4 is three quarters removed from China’s quarantine. The companies are clearly still doing well post-quarantine as they are in a stronger position than pre-quarantine. To fund a cycle/value trade the money is coming from WFH/growth stocks, which may persist in the short run. I don’t think this is sustainable in the medium to long run. 

To conclude, I was thinking – didn’t Chinese retail sales for January/February grow more than 30% year over year? Yes, the year-over-year is a very low bar to overcome, but it shows that the fundamental opportunity in Chinese internet companies has arguably never been better. I’ve unfortunately seen days like yesterday. It comes with the territory I suppose, though it is painful emotionally as well as financially. What I’ve learned is to not act emotionally but keep my eye on the long-run opportunity. For that reason, I was a buyer yesterday in my personal account.  

Key News

Asian equities were largely higher with India an outlier to the downside. The above news was a drag for China and Hong Kong in morning trading, but they did rebound. CNY was off a touch as the US dollar rallied, bonds rallied, and copper was off a touch. 

China’s Twitter Momo (MOMO US) reported Q4 this morning before the US market open. Expectations were low going into the release as the company appears to have exceeded the low bar. Unfortunately, I’m pressed for time this morning so more details tomorrow!

H-Share Update

The Hang Seng pulled a James Bond falling -0.07% as volume increased 5% from yesterday, which is just above the 1-year average. The Chinese companies listed in Hong Kong within the MSCI China All Shares Index were off -0.87% as the communication sector was dragged down by Tencent. Growth stocks were off on the US news but not nearly to the extent as the US shares were yesterday. Hong Kong most heavily traded by value were Tencent, which fell -2.81%, Meituan, which dropped -1.58%, Alibaba Hong Kong, which was off -3.91%, Xiaomi, which fell -4.4% on mixed earnings, China Mobile, which fell -2.11%, Hong Kong Exchanges, which gained +3.17%, Anta Sports, which rose +8.4% on Nike’s opinion-ing on human rights issues is causing a backlash in China benefiting domestic rivals like Anta, PingAn, which gained +0.32%, Wuxi Biologics, which was up +4.49%, and Kuaishou Tech, which rose +0.38%. Southbound Stock Connect volumes were moderate/high as Mainland investors sold $201mm of Hong Kong stocks as Southbound trading accounted for 14.3% of Hong Kong turnover.

A-Share Update

Shanghai, Shenzhen, and STAR Board were off -0.1%, -0.14%, and -0.02% respectively while the Mainland stocks within the MSCI China All Shares were off -0.07%. I was surprised that the STAR Board didn’t do better as there has been a lot of Mainland chatter on supporting R&D. There is also chatter the PBOC could lower the bank reserve requirement ratio, which adds liquidity to the financial markets. Volumes were light, declining -11.53% from yesterday to only 78% of the 1-year average. Many domestic consumer plays were strong as Nike and H&M have opined on human rights issues leading to Chinese consumers boycotts that will benefit domestic players. Foreign investors bought $420mm of Mainland stocks yesterday in moderate volumes as Northbound trading accounted for 6.2% of Mainland trading.

Last Night’s Exchange Rates, Prices, & Yields

  • CNY/USD 6.53 versus 6.53 yesterday
  • CNY/EUR 7.72 versus 7.72 yesterday
  • Yield on 1-Day Government Bond 1.40% versus 1.40% yesterday
  • Yield on 10-Year Government Bond 3.19% versus 3.19% yesterday
  • Yield on 10-Year China Development Bank Bond 3.59% versus 3.59% yesterday
  • China's Copper Price -0.47% overnight