Should investors trust China again after stocks like TAL Education crashed?

Few days ago a friend asked me if I would buy TAL Education. I said no because I am in the education business and I don’t really fancy investing in another.

Most would think that I would have the advantage of knowing the industry better, but sometimes as ‘insiders’ we tend to focus too much on the negative challenges – simply put it’s the “grass is greener on the other side” syndrome. I know, it is a form of bias and we should not let that affect our investment thesis. But I am human too, so I can’t be perfectly rational.

Because of my unwillingness to invest in another education business, I was lucky to avoid the carnage China education stocks faced on 23 Jul 2021.

What happened to China education stocks?

On 23 Jul 2021, a rumour that China is going to clamp down hard on private domestic educational companies started spreading. The leaked details on the clampdown sounded serious:

• Private education providers to become non-profits
• Barred from giving classes on weekends, public holidays and school vacations
• Stop approving new after-school education institutions (actually good for existing companies)

And this was what happened to these stocks that faithful day:

• Zhangmen Education (ZME) – 35%
• Youdao (DAO) – 43%
• New Oriental Education (EDU) – 54%
• Gaotu Techedu (GOTU) – 63%
• TAL Education (TAL) – 71%

That’s super ouch.

China Stocks = Pain?

Investors in Chinese stocks have already started feeling the heat in 2020 when Alibaba was targeted. The Chinese government then moved on to other Chinese tech stocks. And now this.

Investors’ patience and trust are waning. They are feeling betrayed by the Chinese government and many are thinking if they should give up on Chinese stocks to avoid the regulatory risks altogether.

It is normal to have such strong emotions, especially if your money is involved. We are humans, not robots. But it is such strong emotions that tend to cloud our judgement and objectivity. Most investors are probably thinking of giving up on Chinese stocks now because it is the most ‘soothing‘ action to take – just like how we crave comfort food when we are sad.

Humans avoid pain and since Chinese stocks are now inflicting pain, we seek to avoid.

It is not easy to evaluate your Chinese stocks objectively at the moment but you have to try. Ask if the reasons you bought these stocks still hold? Are these enterprises going to worth more than what they are today? Are their potential limited because of policy changes and if yes by how much?

It could be a case whereby you end up with the same conclusion – to sell. But at least you did an exercise to make that call and not just an emotional response.

Institutional investors’ actions have been mixed so far.

• Cathie Wood has openly said she would avoid Chinese stocks because she thinks there’s more room to go down.
• Zhang Kun, China’s largest mutual fund manager, has also pared down Chinese stocks (but more from a valuation perspective) in the second quarter.
• Temasek reported superb results this for last financial year and China remains the largest exposure in its portfolio.
• Charlie Munger‘s Daily Journal Corp still hold an 18% position in Alibaba.

It isn’t a doomsday scenario for Chinese stocks as institutional investors are still holding on to them.

Just take note that the Chinese markets have many retail participants and that tends to make the stock prices volatile.

China has potential but needs a new perspective

I still believe in the potential of a wealthier China and that investors can be rewarded handsomely in the long run. All these short term changes would make China’s growth more sustainable.

However, investors cannot use a U.S. playbook (which most of the investment literature are about) and apply it to China – I illustrated the distinct differences between the two countries in greater detail within our Guide to Investing in China.

We need to understand China in order to know what to invest in and what to avoid.