Cathie Wood sold her Chinese stocks. Should you?

Investing in China has always come with a special set of risks, but for most of modern history investors have been able to ignore them as Chinese growth stocks delivered.

Suddenly, these risks, which include investing in a country where US standards of rule of law and investor protection are non-existent, come to the fore. The Chinese Communist Party wiped out almost all of the value of the for-profit education sector in that country when it said tutoring companies like New Oriental Education Group and TAL Education Group would be prohibited from making a profit and would have to register as a non-profit business.

As a result, a sector worth over $ 100 billion earlier this year imploded, losing almost all of its value, and Chinese stocks as a whole plunged. the IShares MSCI China ETF lost 12.6% in just three sessions, with investors fearing further crackdowns that could erase shareholder value overnight.

Tensions had already risen after Beijing fined $ 2.8 billion on Ali Baba (NYSE: BABA) earlier this year due to anti-monopoly concerns and blocked ridesharing giant Didi Global to list its app on major app stores shortly after its IPO. Additionally, the United States has threatened to write off a number of prominent Chinese stocks, including Alibaba, if it does not open its books to US regulators.

In addition to the massive sell-off, a number of large investors are reported to be bailing out China. Among them is Cathie Wood, director of ARK Invest, which manages a number of popular ETFs including ETF Innovation ARK (NYSEMKT: ARKK), who were big winners during the pandemic. As a result of this success, investors are now closely monitoring Wood’s movements and ARK reports its trades every day. Some investors could follow his example on China.

The great shots of Cathie Wood

Wood was a strong supporter of Chinese tech stocks, holding like Alibaba, JD.com, Pinduo, and Tencent, but ARK Invest quickly sold these shares and closed these positions entirely. He sold all of his Tencent shares on Friday and ARK gave up nearly one million shares each of Pinduoduo and JD.com on Tuesday, or about $ 150 million of the two combined.

Wood’s thinking on the subject was not complicated. During a webinar with investors earlier in July, she said there was a “valuation reset” in China and valuations could stay low for some time. She said: “From a valuation point of view, these stocks have gone down and, again, from a valuation point of view, they are likely to stay down.”

Chinese stocks have long traded at a discount to their US counterparts, but Chinese government meddling is driving valuations generally lower as investors fear further harm to their holdings, especially since they don’t there is no real control over the ability of the Chinese government to do what it wants.

Some investors even believe that the variable interest entity (VIE) structure of many Chinese stocks means that the government could render them worthless, although that seems unlikely. Additionally, the United States has threatened to delist some Chinese stocks if it does not make its financial audits available to US regulators, another source of geopolitical tensions.

Should you sell your Chinese stocks?

It is natural to think about selling your Chinese stocks at a time like this, and whether you should sell your Chinese stocks depends on a few simple questions. First, ask yourself what your risk tolerance is and your time horizon. If you are a risk averse investor or have a shorter time horizon, this might be a bad time to own Chinese stocks. The situation could certainly get worse before it gets better, and it is possible that other stocks will see almost all of their value wiped out like Chinese tutoring stocks have just done.

However, it’s worth remembering that many of the stocks that Wood and other investors sell are blue chip companies. Stocks fall not because the fundamentals of the company have changed, but because investor sentiment has changed, and that can change quickly.

Alibaba, for example, is the world’s largest e-commerce platform, with more than $ 1,000 billion in annual gross merchandise volume and more than 800 million annual active customers. Investors also responded favorably when Alibaba was fined $ 2.8 billion from the government, believing the regulatory risk was now over.

In other words, if these stocks do not face any specific threats like Chinese education stocks and continue to exhibit the kind of growth they have historically had, investors could be rewarded in the long run. for their purchase now. Alibaba, for example, is now trading at a price-to-earnings ratio of just 16 based on expected EPS in 2022, and analysts expect revenue growth to exceed 20%.

Alibaba and its big tech peers will have the opportunity to showcase their results and advocate with investors. A good performance could help investors forget about the crackdown on the education sector.

While Chinese stocks will remain risky for the foreseeable future and regulatory risk should not be ignored, investors are clearly being compensated for this risk at current prices. If you can handle the volatility and have a long-term horizon, taking a small position now could pay big dividends down the road.