Chinese concept stocks

with ups and downs

*Picture source: Tiger Trade

In the U.S. stock market, Chinese concept stocks constitute a unique sector. Generally, these are companies with their main revenue-generating operations in mainland China but are listed and traded on the U.S. stock market. Chinese concept stocks also include companies that are listed in Hong Kong and then traded on the U.S. stock market in the form of American Depositary Receipts (ADRs).

Since the 1990s until now, approximately 500 Chinese concept stock companies have gone public and listed their stocks in the United States. The Chinese concept stock index reached its peak in 2021, after which the market experienced a continuous decline lasting for 21 months. By October 2022, it had reached its lowest point, performing significantly below major global stock markets.

After a significant pullback since 2021, the overall valuation of Chinese concept stocks has fallen to a level below one standard deviation from the long-term historical average, indicating a relatively low valuation.

Jack Ma and Joseph Tsai's increased stake in Alibaba, making them the largest shareholders, is widely regarded in the market as a positive response to the undervaluation of Alibaba's stock.

The buys triggered a rally in Chinese internet stocks. They signaled a shift in the perception of risk in China, showing that Chinese "smart money" sees the nation's equities as undervalued.

Multiple positive catalysts catalyze, signaling a bottoming out

1. Favorable policy developments

• Unexpected cut in reserve requirement ratio by the People's Bank of China: The People's Bank of China announced a 0.5 percentage point reduction in the reserve requirement ratio, effective from February 5th.

• Positive impact of the Federal Reserve's interest rate policy: According to Galaxy Securities analysis, with the Federal Reserve ending rate hikes and initiating interest rate cuts, there is an improved global liquidity situation. This increased liquidity raises the possibility of capital inflows, potentially leading to an overall upturn in Hong Kong stocks.

2. Founder or management team increasing their holdings

• The increased holdings of shares by company founders, executives, or insiders are generally considered a display of confidence in the future prospects of the company. For example, Jack Ma and Joseph Tsai increasing their stakes in Alibaba might suggest that they believe the current valuation of the company is below its intrinsic value.

3. Corporate buyback initiatives

• Wind data indicates that the total amount of share buybacks by listed companies on the Hong Kong Stock Exchange reached HKD 124.6 billion for the full year of 2023, surpassing the HKD 104.9 billion recorded in 2022 and setting a new historical record. It's noteworthy that this buyback trend has been ongoing for three consecutive years.

4. Historical undervaluation zone

*Chart source: Huaxi securities research report

• The chart illustrates the changes in the Price-to-Sales (PS) ratio for select Chinese concept stocks from 2016 to January 26, 2024. The Price-to-Sales ratio, representing the ratio of market capitalization to sales revenue, is a crucial financial indicator for evaluating company valuations.

• The data indicates that the current Price-to-Sales (PS) valuations for some Chinese concept stocks are relatively low, which may reflect the market's perception that these companies are currently undervalued compared to historical levels.

• A low valuation could also indicate investment opportunities, especially when investors believe that the fundamental aspects of these companies remain strong, and the market may be underestimating their long-term growth potential.

How Chinese Concept Stocks React to Buybacks and Interest Rate Cuts

A Historical Perspective

According to research by Hai Tong Securities, a retrospective analysis of market performance from the end of a Federal Reserve rate-hiking cycle to the beginning of the first rate-cutting cycle since 2000 revealed that historically, even before the actual interest rate cuts, there is a high probability of an upward trend in the Hong Kong stock market. Specifically:

• First scenario: From May 2000 to January 2001, the Hang Seng Index in the Hong Kong stock market rose by 6.7%.

• Second scenario: From June 2006 to September 2007, the Hang Seng Index surged by 58.87%.

• Third scenario: From December 2018 to July 2019, the Hang Seng Index increased by 4.52% due to improved liquidity expectations in the Hong Kong stock market as the Federal Reserve paused rate hikes. Additionally, China's reserve requirement ratio cut boosted the market. This rate-cutting cycle coincided with the fifth round of a buyback surge in the Hong Kong stock market. During this phase, the technology and internet sector experienced its strongest growth.