Why Are Chinese Stocks Dropping in the US?

By Chutian Zhou

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The U.S. stock market is recovering amid the COVID-19 pandemic, but the Chinese companies listed in the country have just received a severe blow. Last week, China’s e-commerce giant Alibaba’s stock (NYSE: BABA) fell about 8 percent in three days (from a May 19 high of $217 to a May 22 low of $200). Baidu, a major Chinese internet company, saw its stock drop 6 percent on May 22. Sina and JD.com experienced sudden share drops as well.

What exactly happened to these China stocks? How should we interpret the falling shares despite outstanding earnings (Alibaba, for example, actually reported strong revenue results)? I argue that this is due to the tensions between the two largest economies in the world, and the pessimistic signals released by the Chinese government at the National People’s Congress (NPC). Specifically, watchers should consider factors such as the newly introduced Holding Foreign Companies Accountable Act, China’s missing GDP target, and the tough stance on the Hong Kong issue at NPC.

On May 20, the U.S. Senate passed the Holding Foreign Companies Accountable Act. This is a push to increase scrutiny of U.S.-listed Chinese companies. According to the act, a company will be banned from trading in U.S. securities exchanges if it fails to comply with the Public Company Accounting Oversight Board’s audits. Each company also has to disclose whether it is backed by a foreign government.

The unanimous passage of the act panicked investors and sparked a selloff of securities of Chinese companies, as the Luckin Coffee scandal has been hovering in their minds. China’s Luckin Coffee, traded at NASDAQ, allegedly inflated its 2019 sales.

On the flip side, however, the scandal along with the act should be treated as a golden opportunity by China to make up for its mistakes in the course of opening up the country’s financial sector. While China deserves credit for allowing foreign investors to take a stake in its financial institutions, it needs to realize that a huge gap still exists between a somewhat formidable domestic market and the free, transparent U.S. market. Measures need to be taken by the Chinese government to close that gap. Being more accurate and transparent in the financial statements of publicly-traded companies is an ideal starting point. After all, adopting better financial practices became an overarching agenda of the Xi Jinping-Li Keqiang administration after the 19th Party Congress in 2017.

As for the United States, while it is emotionally satisfying to delist many Chinese companies, such an action is counterproductive because many U.S. investors – both individual and institutional — own stakes in them (e.g. Walmart owns a 12 percent stake in JD.com). In the worst-case scenario, this might lead to a trade war-like clash. U.S. Congress should continue to pressure for transparency, not threaten to delist.

China’s NPC also influences investor confidence. The annual NPC, where the state’s plans and goals are discussed, was postponed to late May because of the virus. The spotlight of this year’s parliament meeting is that, for the first time, China did not set a GDP growth target. As Premier Li Keqiang put it in the Government Work Report, “We do not set the specific GDP target mainly due to the global pandemic and big uncertainties about the economy and trade.” The Chinese government has released seemingly pessimistic signals, which lead to a sharp plummet in prices of China concepts stocks.

In spite of Li’s negative attitude, China emphasized other economic goals: a lower unemployment rate, higher CPI, and a balanced current account. On top of these targets are an expansionary fiscal policy (lower taxes, transfer payments to the “grassroots level,” run a larger budget deficit) and modest but expansionary-prone monetary policy (a lower policy rate, lower reserve requirement, issuing “special treasury bonds,” and the anticipated reverse repo). The Li administration’s plan is also coupled with deleveraging in the financial sector to ensure the smooth revitalization of the real economy. In light of these concrete measures, investors are advised to have confidence in China’s capability to restore the economy. Not setting a growth rate is equivalent to stability rhetoric, not a prediction of recession.

What worries investors more is China’s newly proposed security law as a resolute response to the 2019 Hong Kong protests. Last year, the demonstrations brought unprecedented chaos to the territory. To investors, the potential passage of the law puts the autonomy and economic freedom of the special administrative region in great peril. Hong Kong might no longer be the financial hub of Asia as there will be a mass exodus of capital. It is not groundless to argue that China’s harsh stance on Hong Kong is another factor affecting the stock prices of the Chinese companies.

To conclude, what lies behind the stock market is the worsening U.S.-China bilateral relationship, as the two sides hold different views on a wide range of issues. The silver bullet (and the stimulus) is a COVID-19 vaccine, but this is not likely to happen in the near term. As a consequence, the renewed repercussions are just the beginning.

2020 is an election year. To win re-election in November, President Donald Trump needs someone to blame for the virus — and resulting economic recession. China is in his focus.

Chutian Zhou has a multidisciplinary background in journalism, finance, political science and data analysis. He is a graduate of the School of Global Policy and Strategy, University of California, San Diego, and earned his second Master’s degree from Columbia University with a focus on quantitative social science. He is now based in New York City working as a data analyst.