Aside from cautious views over China’s abrupt and messy reversal of its yearslong COVID Zero approach, investor sentiment over the sector has largely remained positive in recent weeks on a net basis. Chinese stocks with relatively healthy financials like Alibaba (NYSE:BABA) have benefitted from China’s recovery rally in recent weeks, especially as its American and European counterparts face stiffening recession headwinds, making the cohort an attractive corner amid volatile global markets for quick gains on short-term trades.
Specifically, China’s reopening trade has been a key catalyst in recent weeks. Despite ongoing concerns over the lingering aftermath of a messy COVID Zero exit – which has kept businesses closed and people at home, driving economic activity in the region to the slowest pace since early 2020 over the recent New Year holidays – the iShares MSCI China Index (MCHI) has rallied almost 50% from its October low. President Xi and his administration’s commitment to prioritizing economic growth in China this year, and ensuing pledges from key agencies including the PBOC to “support domestic demand” has also bolstered optimism over Chinese equities after years of being blighted by the one-two punch of regulatory crackdowns, and the COVID and property sector drag.
Yet, optimism over the cohort remains cautious at best, given China’s shaky reputation for following through on its growth commitments, its opaque policy agenda, and the ailing property sector’s lack of positive response to recent rescue plans. China’s recent plans to further relax its “three red lines” policy on developer borrowing has already been visited before in early 2022, but failed to yield meaningful results as the property slump continues with home prices falling month over month for a year straight. The PBOC’s recent pledge to “support domestic demand and maintain effective growth of credit” also mimics previous authorities’ vows to restore market stability which has yet to materialize. This leaves investors on the hunt still for a “credible and sustainable shift in regulatory policy”, rather than pledges or new rules and liquidity support that has only been extended in nominal increments every now and then.
But the country does have close to a record-setting $2 trillion in household savings racked up over the past year alone. And converting this sum to “consumption and investment to the largest possible extent” will be crucial to China’s speculated growth target of 4.8% this year, which gives Beijing an extra incentive to make this a priority. China’s abrupt pivot away from its yearslong adherence to COVID Zero might just signal that the central government’s reaffirmed commitment to restoring economic growth is the real deal this time, boosting investor confidence.
This is further corroborated by the robust rally of more than 70% for Alibaba’s stock from its October low, despite mediocre earnings during the October quarter and likely lacklustre results from its annual Singles’ Day shopping event during the December-quarter. With the near-term outlook on global equities still highly uncertain given evolving macroeconomic challenges spanning persistent inflation, aggressive rate hikes, and a looming recession, investors are likely holding a “nothing-to-lose” mentality when it comes to dip-buying on relatively higher quality Chinese equities – and admittedly, Alibaba makes a reasonable pick given its robust market share in Chinese e-commerce and cloud-computing still, alongside attractive shareholder returns via potential stock buybacks.
But from a long-view investment perspective, Alibaba still makes a risky bet in our opinion. The sustainability of its near-term rally buoyed by China’s reopening narrative remains in question, while the latest optimism over Ant Group’s successful capital raise and Jack Ma relinquishing control over the fintech arm of Alibaba may prove premature.
Let’s take a step back – pulling Ant Group from its would-have-been blockbuster IPO at the eleventh hour in late 2020 marked the beginning of a slew of aggressive regulatory scrutiny over Alibaba that has overhauled its growth story over the past two years. While the recent extension of approval from Chinese authorities for Ant Group to “raise 10.5 billion yuan ($1.5 billion) for its consumer unit” potentially marks the end of the regulatory overhang on Alibaba’s stock, it only solidifies the narrative that the days of high-flying growth buoyed by disruption of the industry norm is over. Common prosperity is still very much at the helm when it comes to driving Beijing’s policy agenda, with growth in the private sector – especially for already successful names like Alibaba – coming in second.
Specifically, the yearslong regulatory overhaul on Ant Group is part of Chinese regulators’ fixed playbook still to turn the previously sprawling financial technology firm into a financial holding company. Instead of working with Ant Group to develop new regulations that would support equitable growth in the nascent fintech industry in China, categorizing the firm as a financial holding company would essentially subject it to similar rules as a traditional bank going forward and meaningfully temper its previous growth prospects. As discussed in detail in a previous coverage, financial holding companies inadvertently yield a lower valuation compared to higher growth fintech firms given its relatively subdued fundamental prospects. This, along with other growth-suppressing regulatory changes levied over Alibaba’s core e-commerce, cloud-computing and other direct investments in recent years to level out the tech giant’s sprawling fundamental growth against peers have been key drivers to its battered valuation outlook. Beijing’s tight grip over the private sector, despite recent optimism over the segment’s critical role in China’s near-term growth aspirations, is further corroborated by Ma’s recent handover of his controlling stake in Ant Group via the latest restructuring of the firm’s organizational structure, which effectively reduced his direct holding from a previous ~18% to ~6%.
While it is likely that Alibaba’s depressed valuation at current levels already reflects the near-term weakness in its fundamentals as a result of both local and global macroeconomic uncertainties and the persistent COVID drag (previously discussed here), the latest developments specific to Ant Group continue to highlight the broader risk of Chinese policy pressure over Alibaba. And many institutional investors remain incentivized to sell as breakeven hopes diminish, while others rush to rebalance portfolios to comply with adjusted risk exposures. This accordingly adds another layer of selling pressure on the stock, making hopes for any sustained rally a distant reality.
The Bottom Line
Admittedly, China’s reopening play over the coming months could mark a positive trade opportunity for Alibaba’s stock as investors look for a hedge against the looming global recession that is anticipated to materialize over the same timeframe and weigh on the performance of U.S. equities. But over the longer-term, adverse sentiment over more structural regulatory and geopolitical risks facing Chinese equities will likely take precedent and offset the near-term upside potential on Alibaba’s stock stemming from China’s anticipated economic recovery – especially as Alibaba remains in the middle of China’s on-and-off regulatory assault at home and the U.S.-China crossfire. The risk-off sentiment on U.S. equities is likely to create compelling risk-reward opportunities later in the year, which will lead to a potential “switch-back” in investor preferences, and dull the luster of Alibaba’s stock once again. We remain confident that the stock will continue to face elevated volatility, as investors grapple with the irony of Alibaba’s viable business still against underlying investment risks stemming from external forces that will eventually drive valuations towards a normalized steady-state level near the October lows over the longer-term.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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