Many of China's top stocks were crushed over the past few months as the country's regulators tightened their grip on several high-growth sectors. Alibaba (BABA 0.09%), the country's largest e-commerce and cloud company, was hit by an antitrust probe and a record fine. DiDi Global (DIDI 0.43%), China's largest ride-hailing company, saw its long-awaited initial public offering (IPO) derailed by an abrupt suspension of its core app.
China's education stocks, which soared during the pandemic, collapsed after the government banned for-profit education services. Shares of delivery platforms like Meituan (MPNGF -3.48%), Missfresh (MF 0.47%), and Dada (DADA 0.55%) also crashed as the government demanded better wages and benefits for gig workers.
Image source: Getty Images.
Even Tencent's (TCEHY 1.91%) WeChat, the country's most popular mobile messaging and Mini Programs platform, was ordered to suspend new user registrations. Tencent Music's (TME 2.75%) stock also tumbled after the government ordered it to give up its exclusive music-streaming rights from the world's top record labels. The Cyberspace Administration also recently issued new warnings against more than 100 apps regarding their collection and usage of personal data.
That escalating and unpredictable crackdown has pushed many U.S. investors to unload their Chinese stocks -- but is it really the right time to sell? Let's examine three reasons to dump all your Chinese stocks right now and three reasons to ignore the near-term noise and keep holding on.
Three reasons to sell your Chinese stocks
First and foremost, the Chinese government's recent actions reveal how quickly they can decimate individual stocks and sectors. China believes reining in these industries will reduce income inequality, preserve social stability, and prevent private companies from overpowering the government -- but it's moving so quickly and unpredictably, investors can't catch their breath. That ongoing pressure is rendering analysts' forecasts and valuations for Chinese companies irrelevant.
Second, China forbids foreign direct investments in "sensitive" sectors like education and technology -- but it's turned a blind eye to overseas holding companies called VIEs (variable interest entities), which hold shares of a Chinese company in a "middleman" country like the Cayman Islands. American investors in Alibaba and other Chinese stocks own shares of those VIEs instead of the actual companies.
But with its crackdown on private education companies like New Oriental (EDU 2.77%) and TAL Education (TAL 0.26%), China is officially barring all education companies from raising capital through IPOs or VIEs. If China expands that ban to include other sensitive sectors, the VIE structure could collapse and render U.S.-listed shares of Chinese companies worthless. That's probably why China has been encouraging its top tech companies to launch secondary listings in Hong Kong.
Lastly, the U.S. clearly doesn't want its citizens to own Chinese stocks. It already previously barred U.S. investors from owning shares of government-affiliated companies like China Mobile and intends to delist all shares of U.S.-listed Chinese companies that don't comply with new auditing standards within the next three years.
Three reasons to hold your Chinese stocks
Those threats seem ominous, but there are also three compelling reasons to ignore all the noise.
First, China's goal isn't to destroy all of its fastest-growing companies -- it's merely to prune them, protect workers' rights, and ensure they aren't monopolizing user data or entire industries. In other words, China believes it can trade some short-term pain for stable long-term gains.
Beijing's central business district. Image source: Getty Images.
Second, China realizes its recent regulatory actions are spooking investors. That's why it recently urged foreign brokerages to not "overinterpret" its regulatory actions and declared that the short-term panic didn't reflect its economy's long-term value. China's securities regulator also said it would still allow Chinese companies to go public in the U.S. -- which allays some concerns about the elimination of the VIE structure.
Lastly, the U.S. Securities and Exchange Commission (SEC) hasn't actually started the three-year countdown to delist Chinese stocks. Instead, the SEC has only issued interim rules instead of starting the delisting process.
That delay suggests the U.S. is hesitant to delist Chinese stocks, which would likely hurt the New York Stock Exchange and Nasdaq and discourage other foreign companies from listing their shares on U.S. exchanges. If this countdown never actually starts -- and China eases off its regulatory restrictions -- investors could consider Chinese stocks worthy investments again.
Should you sell or hold your Chinese stocks?
Chinese stocks will remain under pressure for the foreseeable future, so investors who can't stomach the volatility should sell their shares and buy more promising growth stocks in other markets.
However, investors who have a higher tolerance for risk, are willing to hold their shares for a few more years, and are more optimistic about the regulatory challenges should hold their shares for two simple reasons -- many of these stocks look ridiculously cheap right now, and China's economy will likely keep expanding for decades to come.
