Why Did Chinese Stocks Drop Some 13% In October 2022?

Key Takeaways

• The Hang Seng Index, a Hong Kong stock index that features many Chinese companies, was down more than 36% year-to-date and 13% in the month.
• The fall came on the back of Xi Jinping locking in a convention-breaking third term as president of the Chinese Communist Party
• Outsiders feared that the Communist Party’s new leadership, full of Xi loyalists, indicated a less economically liberal future for China and a prioritization of state-owned firms.

The Hang Seng Index, Hong Kong’s main stock index dropped 13.4% over the 30 days ending October 28th and 36.14% year-to-date. The majority of the index’s fall had been caused by a crash in major Chinese stock prices, including the shares of companies like Tencent and Alibaba.

So, what was causing this crash and how should investors react? We’ll break it down.

What was happening with Chinese stocks?

Since the start of the year, Chinese stocks have been on a downward trend, but that trend accelerated in October. The Hang Seng index experienced its largest one-day decline since the 2008 financial crisis, clearly showing just how dire the situation is for Chinese companies.

Over a single weekend, Chinese companies listed on the Nasdaq Golden Dragon China Index, which tracks dozens of Chinese businesses listed in the US, lost more than $73 billion in value, a 14% drop.

These drops caused many foreign investors to sell their Chinese holdings. American depository receipts (ADRs), a tool that allows American investors to buy foreign stocks more easily, of China’s five largest stocks dropped by more than $52 billion.

Most impacted were China’s technology firms, such as Alibaba, Baidu, Pinduoduo, and JD.com.

What’s happened in the wider market?

It’s no secret that it’s been a turbulent year for global markets, but the crash in Chinese stocks was even quicker than the falls in other markets.

Year-to-date, the S&P 500 was down just under 19% to the Hang Seng’s 36% at the end of last month. The FTSE 100, a major London index, was down 6.1% year-to-date.

Given the Chinese market’s major decline while other indices rose slightly or held steady since, something outside of global economic uncertainty was clearly impacting the Chinese market.

The crash itself

It’s typically difficult to point to exact reasons, but the Hang Seng fell one day after Chinese President Xi Jinping claimed a third term as the leader of the Chinese Communist Party, and therefore the country.

From 1982 to 2018, there was a constitutional limit of two consecutive terms for presidents of the Chinese Communist Party. Jinping’s third consecutive term has defied convention and led to concern among international investors.

Another source of concern is the fact that premier Li Keqiang is retiring. Li was viewed as a counterbalance to Xi’s economic policies. Many economists believe Xi will prioritize state-owned businesses over private companies which could impact the growth of businesses listed on the Chinese stock market.

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Those replacing Li and other important players in Communist Party leadership are generally seen as Xi loyalists.

During Party meetings, the Communist Party placed a heavy emphasis on national security. That and recent opposition to Taiwanese independence have also led investors to fear the nation will implement more protectionist policies or crackdown on major technology companies with a global presence.

In short, investors are far more uncertain about how China’s government will lead the country over the next few years than they were a month ago. On top of that, beliefs about Xi Jinping’s policy priorities paint a negative picture for Chinese businesses internationally, leading to a selloff in the nation’s stocks.

Zero-COVID

Another major source of risk that worries international investors in China’s zero-COVID policy. This policy responds to even small outbreaks of the disease with mass testing and weeks-long lockdowns in major cities, which puts significant strain on the country’s economy.

This policy has been highly effective in reducing deaths from the coronavirus. According to the World Health Organization, since the beginning of the pandemic, 28,061 people in China have died due to Covid compared to the United States’ more than 1 million deaths. This is in spite of China having roughly quadruple the population of the US.

Xi Jinping is a proponent of the zero-COVID policy and the Chinese Communist Party’s leadership is now largely composed of people loyal to Xi. This means a continuation of this policy is likely. Many investors fear that continued lockdowns will slow the growth of the Chinese economy, which has also contributed to the selloffs in the stock market.

What investors can do

In light of the crash in Chinese stocks, investors are faced with a few options.

One step that investors can take is to buy the dip, investing in Chinese stocks in response to their crashing prices. If Xi Jinping’s third term doesn’t lead to more protectionist policies or a crackdown on Chinese tech companies outside the country, this could represent an opportunity for investors to buy stocks at a discount while other investors are fearful about their futures.

On the other hand, predictions about the future of Chinese markets could come true. President Xi could choose to prioritize state-owned companies over those listed on the stock market. The Communist Party could also clamp down on companies operating in foreign markets and continued lockdowns in line with the country’s zero-COVID policy could slow or reverse China’s recovery from the pandemic.

Predicting which will happen would require a crystal ball. If you’re interested in foreign stocks, adding Chinese companies to your portfolio now may give you a chance to buy in at a low price, but there are clear risks to doing so.

The Final Word

Though it’s been a turbulent year for markets in general, the Chinese stock market saw major selloffs in the past weeks, largely due to Xi Jinping’s consolidation of power in the country. Many fear that this could slow the economy’s recovery from COVID or lead to increased government intervention in companies listed on the market.

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