Chinese equity markets have seen considerable volatility in recent weeks, culminating in heavy negative moves down in technology stocks early last week. This followed the publication of tough new government regulations on the Chinese private education sector. The new rules ban companies who are teaching the national curriculum in China from generating profits, raising capital, or accepting foreign investments.
China is going through a regulatory upheaval in several industries including fintech, e-commerce platforms, logistics, online-to-offline services and, most notably, education. The severe actions taken in education have led to fears of a wider regulatory crackdown in other sectors. This triggered the broad-based sell-off in non-educational Chinese stocks. We believe it is a mistake to assume what is happening in the Chinese education sector will happen in other sectors of the economy.
The education sector presented the Chinese government with a unique challenge. It had formed what was viewed as a vicious circle, with parents finding themselves obliged to seek ever more private tutoring to prevent their kids from being disadvantaged relative to others in an extremely competitive system. This generated educational inequality based on wealth. Given that the private education sector in China offers no strategic value to the country, the actions chosen are unsurprising. Further, given education is a uniquely political sector, to forecast the regulatory actions taken in the private education sector to other sectors is a gross oversimplification.
Looking past the headlines and noise to assess the opportunities and risks, we find that while in the short to medium-term the regulatory risk issue is here to stay in China, there is considerable opportunity now in deeply discounted stocks, many of which carry limited regulatory risk (Dominion is investing in these names to take advantage). We see it as unlikely that the Chinese government would hamstring its high-quality technology businesses, many of which could be future global champions, and as such the severe negative moves down in the share prices of these businesses is unwarranted. It is important to stay focused on the numbers and not the noise, that is the task of the active investment manager and exactly what we are doing at Dominion.
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