Chinese stocks have also started to soar.

iQIYI and Bilibili surged by more than 15%, JD.com by more than 14%, Pinduoduo by more than 13%, XPeng Motors by more than 11%, Vipshop, Alibaba, and Weibo by more than 10%, and Manbang and Baidu by more than 9%.

It seems like everything is back to normal.

Since February 2021, Chinese stocks listed in the US have declined by more than 70% as a whole, comparable to the historical disaster of the bursting of the global internet bubble in 2000, with a cumulative market value evaporation of RMB 9.5 trillion. Among them, 152 companies have declined by more than 90%, and 196 companies by more than 80%, accounting for 46% and 60% of the total number of Chinese stocks listed in the US, respectively.

Despite the dire situation, there are still many investors who have chosen to go against the trend and buy at the bottom, including top-tier public and private equity funds and a large number of retail investors.

As of the end of the second quarter of 2024, eight Chinese stocks, including Pinduoduo, Manbang, New Oriental, FUTU, ZTO Express, and Alibaba, were among the top 20 heavily weighted stocks of Jinglin Asset Management, with a market value of US$1.83 billion, accounting for nearly 50% of the total US stock positions. In addition, except for ZTO Express and Qifu Technology, the remaining six Chinese stocks all increased their positions to varying degrees in the second quarter.

Gao Yi Asset Management was even more aggressive in its overseas allocation of Chinese stocks. As of the end of the second quarter, it held shares in 19 US stocks, 15 of which were Chinese stocks, including Pinduoduo, Huazhu, NetEase, iQIYI, Tencent Music, etc. The total market value of these holdings was US$760 million, an increase of US$200 million from the end of the first quarter.

On the public fund side, Yifund Asia Select, led by Zhang Kun, had three Chinese stocks (Hong Kong stocks) among its top ten heavily weighted stocks, including Giant Network Group, Ctrip.com International, and Meituan, with the first two being newly added in the second quarter.

In addition to institutions, a large number of retail investors have also taken advantage of ETFs to go against the trend and buy Chinese stocks at the bottom. The most typical example is a certain Chinese internet ETF, which has increased its holdings from 3.4 billion shares in February 2021 to 34.8 billion shares today, an increase of nearly tenfold, and its market value has expanded from RMB 8 billion to about RMB 35 billion.

Investors who bought at the bottom have long been dormant, waiting for Chinese stocks to hit bottom and reverse course.

The depth of the decline and the duration of the adjustment in Chinese stocks have both set historical records. The main reasons for this grim situation include three major negative factors: industry policy, earnings fundamentals, and high valuations.

First, regulatory policy interventions have accelerated a sudden change in the outlook for the internet industry.

As early as November 2020, the State Administration for Market Regulation drafted the "Anti-Monopoly Guidelines for the Platform Economy (Exposure Draft)." This was a landmark event that marked the beginning of China's antitrust regulation and the prevention of unorderly capital expansion.

The following April, a major e-commerce giant was fined over RMB 18 billion, marking the end of the era of unchecked growth for Chinese internet companies. Since then, regulation has become the norm, placing constraints on the rapid development of the internet industry.

Against this backdrop, profound changes have taken place in the "quantity and price" dimensions of China's internet industry.

On the one hand, the number of internet users in China and internet penetration have accelerated towards their peaks. In 2020, due to the pandemic, more people chose to go online. In December of that year, the number of internet users soared to 989 million, a significant increase of 85.4 million from March, with internet penetration reaching over 70%. Since then, the growth rate has declined sharply, and by the end of 2023, the number of internet users was 1.092 billion, with a penetration rate of 77.5%, approaching the ceiling.

On the other hand, internet companies have engaged in price wars, especially among e-commerce platforms.

From 2020 to 2022, the first phase of the e-commerce price war began. Alibaba and JD.com chose to launch Taote and Jingxi, respectively, to compete head-to-head with another major e-commerce giant to compete for the lower-tier market and consolidate their existing market share.

In the first half of 2023-2024, a comprehensive price war broke out among e-commerce platforms. On the one hand, consumer differentiation was evident, with consumers favoring low-priced, high-quality products. On the other hand, short video platforms led by Douyin, Kuaishou, and Xiaohongshu continued to rise, taking away a significant share of the e-commerce pie and intensifying competition for existing market share.

As a result, the overall earnings growth of Chinese stocks has returned from high-speed to medium-low speed, with a significant negative growth in 2022. Moreover, the net profit margins of most Chinese stocks have remained volatile and declining over the past four years, leading to varying degrees of decline in return on equity.

While actual performance is one aspect, expectations are a more critical factor in determining pricing. However, due to policy interventions, the "quantity and price" dimensions of the internet industry have undergone rapid changes, reversing market expectations from extremely optimistic to extremely pessimistic, driving a sustained and significant decline in Chinese stocks.

In addition, the collapse of Chinese stocks is closely related to their high valuations before the plunge. In February 2021, the overall P/E ratio of Chinese stocks was over 75 times, with many leading internet companies exceeding 100 times. As a result, institutions had clustered together to drive up valuations significantly over the previous year, creating an obvious valuation bubble.

Under multiple negative factors, the high valuations of Chinese stocks have ultimately undergone a significant regression through share price declines. Nevertheless, after a prolonged period of share price declines and valuation digestion, the darkest moment for Chinese stocks may have passed.

It is worth noting that the lowest price of Chinese stocks since 2021 occurred in October 2022, and even in the midst of the panic in early February 2024, they did not fall below that previous low.

In the view of market capitalization, Chinese stocks are poised to experience a solid valuation recovery in the future.

First, they have declined by more than 70% over the past four years, fully pricing in significant negatives such as policy and earnings, and possibly overdoing it on the pessimistic side. According to Wind, as of September 23, the valuation of Chinese stocks was 17.75 times, far below the median and opportunity values of the past five years.

Second, whether it's industry regulation policies for e-commerce, education, or gaming, they have eased significantly. Moreover, the performance of leading internet companies with higher weightings has not decelerated as much as expected.

According to data from Value Investing Statistics, the top 10 Chinese stocks (Tencent, Alibaba, JD.com, Pinduoduo, Meituan, Baidu, Kuaishou, NetEase, Ke Holdings, and Bilibili) generated revenue of RMB 994.95 billion in the second quarter of 2024, a year-on-year increase of 10.3%. Their non-GAAP net income attributable to shareholders was RMB 203.496 billion, up 33.7% year-on-year. In addition, their gross margin was 38.7%, and their operating margin was 16%, both of which have improved compared to previous quarters.

Third, the Federal Reserve has officially announced a 50 basis point rate cut in September and expects another 50 basis point or more rate cut within 2024. As a result, the dollar will inevitably flow back into emerging markets, providing an upward pull for Chinese stocks, which are at a global valuation low.

However, it is likely that the performance of Chinese stocks will diverge in the future, and more attention should be paid to leading stocks that have risen significantly against the trend during the recent sell-off. These stocks often represent more robust fundamentals, with alpha sufficient to offset the strong impact of beta. Once the market recovers, they are likely to benefit significantly.

For example, among the top 18 Chinese stocks by market capitalization, only Ctrip.com International recorded a gain of more than 28% against the trend.

On the one hand, its existing earnings fundamentals are strong. From 2022 to 2023 and the first half of 2024, its net profit has maintained triple-digit growth, and its profitability has also improved.

On the other hand, market expectations for future earnings growth are not low. In the domestic market, Ctrip.com International holds the largest share of the online travel market, dominating most of the negotiated prices for mid- to high-end hotels. It relies on its early accumulation of tourism resources and a large number of high-net-worth customers to fend off attacks from other online OTA platforms.

In overseas markets, Ctrip.com International has replicated its Chinese experience in the Asia-Pacific region – initially gaining market share in emerging markets with low concentration by offering cost-effective services. Furthermore, inbound tourism to China has surged after policies such as visa-free travel have been implemented, giving Ctrip.com International an advantage in serving overseas customers.

Another example is Legend Biotech, which surged by more than 75% against the trend during this period. In terms of existing earnings fundamentals, revenue has grown by double or even triple digits in each of the past six years, although net profit has remained in the red for over six years. On the expectation front, Legend Biotech has won significant market value growth in the capital market due to its breakthrough progress in CAR-T cell therapy (a cancer treatment method that involves modifying a patient's T cells to recognize and attack cancer cells).

In conclusion, after experiencing an epic collapse, Chinese stocks are highly likely to experience a valuation recovery during the Federal Reserve's interest rate cut cycle in the future. It is essential to pay more attention to leading stocks that have risen against the trend in the past. The storm has passed, and there is no reason to remain pessimistic about Chinese stocks.

Disclaimer

The content related to listed companies in this article is based on the author's personal analysis and judgment based on information publicly disclosed by the companies in accordance with their legal obligations (including but not limited to interim announcements, periodic reports, and official interactive platforms). The information or opinions in this article do not constitute any investment or other business advice. Market Value Observer shall not be liable for any actions taken based on this article.

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