Jun 2, 2021 9:38AM EDT Credit: Getty images
O ne of the things that a couple of decades in dealing rooms around the world taught me was that no matter where you were, traders and markets always overreact. That was true in the short-term, where the first few minutes of reaction to a news story or data release is usually followed by a retracement, and in a longer-term sense, where trends in traded securities often continue way past their logical endpoint. That trend overreaction has been evident for a while now in one particular area of the market, Chinese internet stocks. However, there are signs that a reversion to fundamentals is underway in the sector, making many of the stocks look like bargains at current levels.
Whenever you talk about Chinese stocks, of course, there is one risk that can’t be ignored: government risk. It is easy to forget sometimes that for all its recent push towards individual entrepreneurship and a capitalist system, China is still a one-party state that is, in name at least, communist. That means that, at any time, any business is subject to the whims of the regulators, who will always say that their actions are in the interests of the people. Successful companies have learned how to navigate that environment, but the party still flexes its muscles occasionally.
That is what happened recently. China learned a long time ago that you can’t really regulate or control the internet, other than by controlling the companies that provide access to it. So, when criticism of the regime began to grow after their heavy-handed response to the situation in Hong Kong, they started to clamp down on the likes of Alibaba ( BABA ), JD.com ( JD ), and Baidu ( BIDU ). The stated reason was that these companies had gotten too big, and that they had made unauthorized acquisitions to grow. That may be true and I’m sure that a privately owned entity that sprawls across retail and finance is scary to a totalitarian regime, but that kind of growth was nothing new and the crackdown came as criticism of the regime grew.
That suggests that once the message to any company thinking of criticizing the government has been sent, things will get back to normal. It may be that there will be some adjustments, such as banking and finance arms being spun off, but growth in core businesses will resume. That is presumably why stocks in the sector have stabilized in the last couple of weeks and begun to recover, but the political risk still exists for individual stocks.
The biggest hit has come to Alibaba, so that may seem to be the place to start bargain hunting. There is, however, a potential problem. Criticism of the company has been aimed squarely at its high-profile co-founder, Jack Ma, whose open and vocal support for free markets in China probably makes some of the Communist Party hierarchy see him as a political threat, not just an economic power. Even if the situation overall improves, that may lead to BABA being singled out for regulation and action, so there is still a lot of risk there.
The general point here, however, is that not even a totalitarian government can put the internet genie back in the bottle. Individual companies will ebb and wane, but the industry as a whole will continue to grow. For that reason, the best way to play an expected bounce back is probably with an ETF, and there is only one that offers an unleveraged pure play on Chinese internet stocks, the KraneShares CSI China Internet Fund ( KWEB ).
The fund does hold the big boys, of course. BABA and BIDU combined account for around fifteen percent of holdings, but there are 42 other stocks as well, making it likely that if there is a forced breakup of a big company, for example, ownership of the division will still be within the fund. That, though, is a relatively minor concern and the broad case for owning KWEB is simple.
Chinese internet stocks have been under pressure, but that pressure, as is usually the case with market moves, has been overdone. That makes the sector look like value. However, the peculiarities of the Chinese system put a premium on diversity, even within a single sector. So, for those looking to play either the short-term bounce back or the long-term potential of internet stocks and e-commerce in China, KWEB looks like the best answer.
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