With fear at a fever pitch, is it time to chase Chinese stocks?
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Whether it's electric vehicles, eCommerce giants or online education, there's no shortage of Chinese companies that appear attractive to U.S. investors right now -- at least on the surface.
After all, it's not often that big Chinese stocks like Alibaba (NYSE:BABA) or Tencent (OTCPK:TCEHY) drop 50% or more and settle into price-to-earnings ratios more befitting consumer-staples stocks than fast-growing tech offerings.
Indeed, some Chinese stocks have seen sudden pops as recently as March that suggest some significant chances for quick gains. For example, Nio (NYSE:NIO), Li Auto (LI) and Xpeng (XPEV) all saw more than 20% swings in March as Chinese regulators appeared to take their foot of the gas of Beijing's recent crackdown on hot firms.
Similar moves have also followed financing deals, and there's some optimism that a flailing Chinese economy will encourage state regulators to prop up some ânational champions.â
Additionally, BYD Co. (OTCPK:BYDDY) bettering its peers might offer some perspective on bifurcation in the market and an opening for stockpickers. 
However, such apparent opportunities could be quickly scuppered by some significant overhangs that are associated with these stocks. For instance, Chinese stock face not only potentially greater regulation on both sides of the Pacific, but also a stubborn adherence to Chinese COVID policies that could curtail any opportunity for even the nimblest of traders.
In short, there's more than enough risk for any contrarians at this point:
Beijing Bears Down
The woes of the Chinese tech sector are well understood, and have been boiling over to such an extent that BABA founder Jack Ma essentially disappeared for a while.
Companies like Pinduoduo (PDD) and Tencent (OTCPK:TCEHY) also took to promoting major investments in the billions of yuan to bolster a state-promoted Common Prosperity program. Meanwhile, the Chinese educational-tutoring sector firms like Gaotu EduTech (GOTU), New Oriental Education & Tech (EDU) and Tal Education (TAL) were decimated by crackdowns to the tune of over 90% declines in the past year.
If those volleys were insufficient, Ant Financialâs canceled IPO and DiDi Globalâs (DIDI) upcoming delisting should have been the definitive warning shots that Beijing was not keen on letting its largest tech players tap US markets any longer. 
Yet these impacts did not appear to immediately erode the appetite of US investors for Chinese ADRs. Much to the contrary. According to Reuters, clampdowns and wild swings in the summer of 2021 only fueled record trading levels. Even the famously judicious Charlie Munger was adding meaningful exposure into the close of 2021. As another cycle begins, there may be a similar temptation in play.
Indeed, the amount of firepower put forth by Chinese regulators thus far might suggest the worst is already over. In fact, BlackRock made an argument to that end multiple times in the past year.
The Larry Fink-led asset manager recommended beefing up allocations to Chinese assets significantly late last year, adding that the risk/reward was too great to ignore even against understandable headwinds.
But this dovish perspective was soon after met with a rejoinder from Credit Suisse in 2022.
âMonetary policy is being eased while elsewhere it is being tightened,â the firmâs global strategist Andrew Garthwaite wrote in January. âEconomic momentum is turning up.â
Numerous firms began to publish research adding to bullishness on the beleaguered market shortly afterward. A common refrain came in the form of advising the worst was already over.
âYes, China is struggling with growth and a stronger USD is not good news for Chinaâs stock markets,â an HSBC report from early February read. âBut thatâs now well-known and is priced in. Even good, blue chip stocks are now trading at attractive valuations.â
SEC Sets Its Sights on Audit Issues
Yet that calculus has quickly changed into the second quarter. This time, the U.S. is the nation bearing its regulatory teeth and making those previously âattractiveâ valuations look downright lofty.
âAs more China-based companies have listed in the US, there has been growing concern about the lack of transparency into accounting and governance standards of Chinese firms,â an SEC Risk Spotlight document states. âIn addition to the risks regarding an inability to conduct due diligence to verify the soundness of accounting and governance standardsâ¦ the design and control of the Chinese financial market by Chinese authorities creates a series of potential concerns for US investors related to disclosure, liquidity, volatility, fraud, and risk management.â
Making good on remedying these risks, the regulatory body recently leveraged the Holding Foreign Companies Accountable Act to add over 80 firms to a list of firms due for delisting. This included Xpeng (XPEV), JD.com (JD), Pinduoduo (PDD), Li Auto (LI), Nio (NIO), Luckin Coffee (OTCPK:LKNCY) and NetEase (NTES).
Rather than fight this designation, it would appear the Chinese firms are accepting the pending ruling. Indeed, NIO (NIO) is apparently already considering a potential secondary listing in Singapore to be fully fungible with the U.S.-listed ADR shortly after acknowledging receipt of the SECâs regulatory warning.
Luckin Coffee (OTCPK:LKNCY) followed suit on Monday, indicating interest in listing in Hong Kong after being ousted from the Nasdaq. 
Meanwhile, shares across the Chinese EV and tech spaces have reeled as a result of the regulatory filings to the point where they look increasingly shaky moving forward. In the end, it may be Washington, not Beijing, that puts the final nail in the coffin for the U.S.-listed stocks.
The Persistence of Zero-COVID Policies
Even aside from the politics and regulatory risks, the depressed valuations among many of these stocks may be reasonable on their face.
In large part, this is due to a strict adherence to lockdown policies pursued by Chinese authorities in even its largest metropoles. 
A recent op-ed from the state-sponsored Global Times puts the governmentâs perspective in clear terms. Citing the 267 million people aged 60 and above in the nation, rejecting any call to come off of its strict anti-pandemic measures. 
âWe must not 'lie flat' in any form, but must stick to the dynamic zero strategy, take the initiative in the epidemic fight, and be strict in epidemic control,â the article declares. âThe so-called herd immunity essentially means to drive out a large number of the vulnerable people with low immunity. This is a cruel social Darwinism. In contrast, China has protected the elderly and the patients with underlying medical conditions, which is very remarkable.â
The firmness of Chinaâs adherence to this strategy was only cemented last Thursday during a meeting of the Politburo Standing Committee. The body vowed to âunswervingly adhere to the general policy of âdynamic zero-Covid.â
The committee added that any doubts about the partyâs policy permeating public opinion should dutifully be snuffed out. As a pivotal Communist Party National Congress is expected for November, there should be no expectation that this changes in the near-term.
EV sales dropping precipitously and consumers are already burdened as the real estate sector sees unprecedented turmoil, crushed by stay-at-home orders. That calls for caution about the overall Chinese economy.
That is not to mention supply chain constraints that emanate from major cities of economic importance like Shanghai and Shenzhen.
Bottom Line
Many traders have strong contrarian streaks. After all, the best trades are often made at the precise time when other investors capitulate.
For prominent tech names, the capitulation is more likely to come in the form of companies' own will to continue listing in the U.S. For others, such as the Chinese online-education sector that finds itself in the crosshairs of Xi Jinpingâs flagship economic plans, there is reason to believe these companies are not long for this world. All of this only adds to significant macroeconomic overhangs that temper any modicum of enthusiasm that could still be mustered.
That is not to say there will not be short-term bounces. There will more than likely be signs of life that poke through as fears fuel some swings. 
However, thereâs a saying in Texas (and perhaps even in Tennessee) that if you get fooled twice, you canât get fooled again. That malapropism may hold some wisdom amid the extended sell-off in Chinese ADRs.