How Chinese Shares Went Haywire: ‘The Market Is Completely Unstable’

This month, however, the turmoil reached a new pitch, as investors worried about whether China could suffer Russian-style financial isolation, while more bad news emerged on Covid-19 and on regulatory pressure from both Beijing and Washington.

In recent days the market was gripped by panic selling, in one of the biggest episodes in the history of China ADRs, said Tony Chin of Infini Capital Management Ltd.

“People were basically selling with no price limit—they just wanted to de-risk,” said Mr. Chin, the founder and chief executive of Infini, a Hong Kong-based hedge fund manager.

There is a lot at stake for international investors. U.S. institutions now hold about $750 billion worth of Chinese shares of all sorts, Goldman Sachs analysts estimate, while many individuals also hold U.S.-listed Chinese shares or exchange-traded funds.

The latest rout began March 10, after the U.S. Securities and Exchange Commission provisionally named five Chinese companies whose audit papers it couldn’t inspect, a move toward eventual delistings under the Holding Foreign Companies Accountable Act.

Taken alone, this was an incremental step in the gradual decoupling of American and Chinese markets. But it prompted investors to revisit the big question of how investible Chinese stocks are, an issue that blew up last year when Beijing took down after-school tutoring companies.

Days earlier, Norway’s $1.4 trillion sovereign-wealth fund ditched a Chinese sportswear stock over forced-labor concerns. And Moscow had just been frozen out of global finance for its attack on Ukraine, with

MSCI Inc.

kicking the now “uninvestible” Russia out of its influential emerging-markets indexes.

“The fate of the MSCI Russia Index painted a vivid—and terrifying—picture for what could happen in the event of a diplomatic breakdown between U.S. and China,” Sanford C. Bernstein analyst Robin Zhu later wrote to clients.

As the weekend arrived, Chinese technology stocks had shed almost $2 trillion in value from a $3 trillion peak in early 2021, Goldman analysts estimated.

The heavy selling continued into the following week, with news of rising Covid-19 infections and lockdowns in cities like Shenzhen adding to the gloom. Analysts at

JPMorgan Chase

& Co. downgraded dozens of internet stocks, saying the market’s focus had shifted to risk management “as global investors price in China’s geopolitical risks.”

And regulators showed few signs of easing up on corporate China, with The Wall Street Journal reporting that

Tencent Holdings Ltd.

was facing a potential record fine from the central bank. By the end of Monday, March 14, U.S. ADRs had dropped an unprecedented 29% in three sessions. The selling continued in Asia on Tuesday, though U.S.-listed stocks regained a little ground.

Then midweek, everything changed. Top Chinese policy makers stepped in on March 16 to talk the market back up, with officials led by Liu He, President

Xi Jinping’s

top economic adviser, promising market-friendly policies and pledging to keep capital markets running smoothly.

“The Chinese government has never issued something as strong as this to support capital markets,” said Mr. Chin at Infini Capital.

The reaction was rapid and fierce. U.S.-listed Chinese companies gained $242 billion in a day, S&P Global Market Intelligence data shows, with a Nasdaq index jumping by an unprecedented 33%.

Blue

chips traded like penny stocks:

Alibaba Group Holding Ltd.

’s ADRs leapt a record 37%, in trading volumes only exceeded by the day of the e-commerce giant’s listing.

“The market is completely unstable,” said Alexandre Tavazzi, global strategist and chief investment officer for Asia at Pictet Wealth Management, speaking as stocks surged. “The pricing is very dependent on short-term supply-demand dynamics and less on fundamentals.”

The end result was something of a round trip: By the close on Friday, March 18, the Nasdaq Golden Dragon China Index stood about 3.4% higher than it did two weeks earlier, while Hong Kong’s Hang Seng had lost 2.3% over the same period, Refinitiv data shows.

The roller-coaster ride demonstrates how much Chinese shares remain at the mercy of politics and news headlines, even as they play a growing role in international investor portfolios. While that is a familiar issue for emerging-market investors, it makes them less appealing than companies that can be valued largely on their underlying businesses.

After the convulsions, investors are scrambling to understand how much has really changed.

Chinese authorities have tried to soothe investors before, but the pressure wasn’t off for long. While a top regulator moved in July 2021 to reassure global financial firms after the tutoring clampdown, it wasn’t long before the property sector was engulfed in a crisis—and another tech giant,

Meituan,

found itself in officials’ crosshairs repeatedly.

On delisting, there are reasons for optimism. Many companies have, or could get, second listings in Hong Kong as another way to access global capital markets, while some companies including big telecommunications operators have already been delisted with little practical effect. Chinese officials have also repeatedly said they want to resolve the issue.

Numerous investors also argue there is no fundamental problem with investing in China and the long pullback has made some stocks attractive.

“We strongly refute the notion that ‘China is uninvestible,’” said

Justin Thomson,

chief investment officer and head of international equity at

T. Rowe Price Group Inc.

“It would appear that the market is pricing in extremely negative sentiment while ignoring potential positives such as extremely cheap valuations and the opportunity for further easing in the economy.”

Likewise, Conrad Saldanha, senior portfolio manager on the emerging-market equity team at Neuberger Berman Group LLC, said a broad-brushed dismissal of Chinese stocks would be wrong and he still saw investment opportunities in some internet companies, as well as hardware and consumer businesses.

However, other issues that have pressed down on Chinese stocks appear more intractable. Markets world-wide remain jittery about inflation, rising interest rates and global growth.

And the advantage China once enjoyed as “first in, first out” of the pandemic has faded, as it targets a relatively modest 5.5% growth rate for this year and experiments with adapting its zero-tolerance approach to Covid-19.

China’s slowdown will affect consumption and profit growth, while its property sector has yet to show signs of recovery, said Mr. Tavazzi at Pictet, which hasn’t held Chinese stocks in its discretionary portfolio for about a year.

Restoring investor confidence could take time. Mark Martyrossian is a director at Aubrey Capital Management Ltd., a boutique investment firm specializing in global growth stocks that manages a China-focused strategy.

In late 2021, he met with some 30 institutional investors in the U.S. to pitch Aubrey. But most of those investors were worried about further business regulations and the sentiment hasn’t shifted since then, he said.

“People are just not wanting to take risk, and that is understandable,” he said.

—Serena Ng contributed to this article.

Write to Quentin Webb at quentin.webb@wsj.com and Dave Sebastian at dave.sebastian@wsj.com