Chinese stocks are rising, but shadow of doubt hangs overhead

Chinese stocks have gotten some boost from investors who are finding their valuations too cheap to ignore. Within the past week, shares of Chinese companies have been simmering. Stocks of (JD:NASDAQ), Tencent (TCEHY:OTCMKT), and Baidu (BIDU:NASDAQ) have risen by 24%, 12%, and 12% respectively. Chinese companies have added more than $80bn to their valuations this week

Despite their recent impressive run, Chinese stocks have been impaled on a year-to-date basis. Shares of Did Global Inc. (DIDI:NYSE) have fallen by 40% since the company went public on June 30th, while Alibaba (BABA:NYSE) has declined by 28% so far this year. Shares of and Tencent have slipped by 12% and 15% respectively

Prices of Chinese stocks cratered following a slew of regulatory crackdowns from government agencies. Over the past year, China has tightened regulations against its biggest companies, aiming to curb their growth and give the government greater control and access to their data.

Last week, China’s market regulators released a lengthy list of rules barring the country’s tech companies from using data to influence consumer choices and “traffic hijacking activities.” This was a follow up to the five-year blueprint for an antitrust-focused crackdown released earlier in the month.,

The rapid pace at which new laws are being enacted, plus the swift punishments and investigations from authorities cast a huge shadow of doubt over the future of Chinese companies. This has led to a sell-off as investors offloaded their shares over mounting uncertainty. respectively.

The murky environment has also not gone unnoticed by regulators in the US. The Securities and Exchange Commission has issued tighter regulations against Chinese companies listed on US exchanges. Earlier in the week, SEC Chair Gary Gensler stated that the commission was looking to enforce a three-year deadline for Chinese companies to allow the regulator to inspect its financial audits. Any company that refuses to comply risks being delisted.

Last month, SEC suspended new public listings from China-based companies until they clarified the potential pitfalls that shareholders faced. U.S. lawmakers have already passed legislation that empowers the regulator to close any loopholes that allowed Chinese companies to shield their books from U.S. inspectors.

However, whist most investors are staying away from what seems to be a keg of gunpowder, others seem to be bottom-fishing and by buying the dip. Some money managers are seeing the sell-off in Chinese stocks as a buying opportunity, choosing to sidestep the prevailing noise about Chinese regulations.

Cathie Wood is among institutional investors taking advantage of the steep drop in price. Her fund, ARK Invest, snapped up about $12 million in shares earlier this week. Her move comes barely a month after ARK Invest reduced its position in Chinese companies significantly.

Based on growth forecasts, and free cash flows, Chinese sticks look dirt cheap to investors looking for a good bargain. The second-quarter earnings beat by most Chinese companies has also boosted investors’ confidence. Tencent’s net profit for the quarter beat wall street expectations while Baidu’s revenue for the second -quarter beat analysts’ forecast. Earlier in the week, shares of spiked 15% after the company released its earnings report which was very positive. These investors are placing bets on the performance of the stock between 2 to 5 years from now when regulatory issues must have settled.

However, Chinese companies presently look undervalued amidst an impressive fiscal performance, the overhanging risk from regulators should not be ignored. It appears there is no finish line in sight for regulatory issues as the government is not showing signs of letting up just yet.

Perhaps more worrisome is the recent statement from the Chinese President, Xi Jinping who called for the redistribution of wealth in the nation which he intends to achieve by regulating “excessively high incomes.” Such utterance signals that the government would place restrictions on how far Chinese companies can grow.

Beijing has repeatedly shown that it is not shy of flexing its muscle to reign in its big companies. With such a high risk in focus, anyone betting on Chinese companies may well be betting against the Chinese government.