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A Bullish Take on China’s Crackdowns and Alibaba Stock

It’s been an absolutely brutal year for Alibaba (NYSE:BABA) stock investors. And I would know – I’m one of them. But anyone who has followed Alibaba already knows that BABA stock is down 42.3% since the beginning of December 2020.

You’d never guess BABA stock would have such abysmal returns based on Alibaba’s underlying business, however. In the most recent quarter, Alibaba reported 33.8% year-over-year (YoY) revenue growth and $45 billion in net income.

So what’s going on?

Why Is BABA Stock Tanking?

BABA stock isn’t tanking because of anything having to do with the company’s booming e-commerce or cloud services businesses. It’s tanking because Chinese regulators are burying a company that a year ago was the poster child for optimism on China’s long-term economic outlook. Alibaba was the Chinese Amazon (NASDAQ:AMZN). Investors heard it a million times.

In reality, Alibaba still is the Chinese Amazon. But AMZN stock is up 66.5% in the past three years while BABA stock is down 7.5% in that time. China’s economy is growing much faster than the U.S. economy, and Alibaba’s revenue is growing much faster than Amazon’s. So why is AMZN soaring while BABA stock is plummeting?

I don’t think anyone is very confident about what is going on. But I have a theory that I haven’t seen discussed anywhere else, so I want to share it here.

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Self-Inflicted Wounds

In 2019 and 2020, when there was a trade war raging between the U.S. and China, I was never concerned about an outright war between the two countries. There’s simply too much money on the line. China makes things and we buy them. That simple dynamic is the driving force of both economies.

It’s a rule of human nature that people always end up doing what’s in their own best interest. But China is contradicting that rule by repeatedly cracking down on Alibaba, its most visible internationally listed stock. First, China banned the initial public offering of Ant Financial, the digital payment company in which Alibaba holds a 33% ownership stake. Since then, Chinese regulators have repeatedly fined and reprimanded Alibaba and a number of other Chinese tech, for-profit education, online-gaming and real-estate companies.

The million-dollar question that has been bugging me for months is why? Year-to-date, the SPDR S&P 500 ETF Trust (NYSE:SPY) is up 17.6%. In that same time, the iShares China Large-Cap ETF (NYSE:FXI) is down 16.1%.

The world is watching, and it’s getting a clear message: Don’t invest in Chinese stocks. U.S. stocks go up, and Chinese stocks go down. U.S. stocks grow revenue and compete in a free market. Chinese stocks that are too successful get beaten down by the Chinese Communist Party.

But why? The CCP must see that they are absolutely wrecking their international reputation. China benefits greatly from international investments. Why is the CCP destroying China’s brand as a high-growth emerging market investment opportunity and replacing it with the perception that Chinese companies and stocks have a ceiling on their success?

Is China’s Crackdown Really a U.S. Crackdown?

The U.S. Securities and Exchange Commission has been extremely vocal about its problems with Chinese stock disclosures for years. In August, SEC Chairman Gary Gensler told Bloomberg that the “clock is ticking” for Chinese stocks listed in the U.S. They must comply with U.S. accounting standards or risk being delisted from U.S. exchanges.

Roughly 400 Chinese and Hong Kong companies are currently listed on American exchanges. All of these companies are subject to the 2020 Holding Foreign Companies Accountable Act, which gives them a three-year window to comply with U.S. accounting standards or risk being delisted.

Here’s where the conspiracy theory comes in.

Assuming China knows U.S. regulators aren’t bluffing, it has two options. The first option is to do nothing and watch U.S. regulators highlight that Chinese companies have unacceptably ambiguous financial reporting. They can let U.S. regulators tell the world that nobody should invest in garbage Chinese companies.

The second option is for Chinese regulators to take power into their own hands and force their own companies to get in line. In that scenario, the Chinese government is the one in control, or at least that’s how it would look to the global audience. U.S. regulators are actually the ones applying the pressure, but China is seemingly the one cracking down – and it might look similar to the way it’s been cracking down on Alibaba. Essentially this scenario allows China to save face and not make it seem to the rest of the world that the U.S. is swooping in and policing its companies.

Takeaway for BABA Stock

Is the U.S. actually the one responsible for the Chinese crackdown on its own stocks? I have no idea. But it makes more sense than China shooting its own international reputation in the foot for no reason. I first invested in BABA stock back in late 2015 at a price of $68 per share. I’m still long BABA stock and hoping for the best.

If China is simply doing the bidding of U.S. regulators, the bull thesis is alive and well as long as Alibaba eventually meets U.S. accounting standards. However, if the CCP is simply on some power trip where they care more about proving who is in charge than they do about making money or preserving China’s international reputation, BABA stock may be headed even lower.

On the date of publication, Wayne Duggan held a long position in BABA. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.

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