Why Are Chinese Stocks Alibaba, JD.com, Baidu And More Tearing It Up Today?

Chinese internet stocks Alibaba Group Holding Ltd (NYSE:BABA), 500.com Ltd (NYSE:WBAI), JD.Com Inc(ADR) (NASDAQ:JD), Baidu Inc (ADR) (NASDAQ:BIDU), and Qihoo 360 Technology Co Ltd (NYSE:QIHU) are all up in morning trading as sentiment towards Chinese stocks changes for the better. Shares have been volatile in recent months as investors worry about the slowing Chinese economy and a depreciating yuan. Let’s find out why they’re rallying and analyze any relevant hedge fund sentiment towards each of them.

Wall Street Bull

We mention the sentiment of elite investors because our research has shown that elite funds are extremely talented at picking stocks on the long side of their portfolios. It is true that hedge fund investors have been underperforming the market in recent years. However, this was mainly because hedge funds’ short stock picks lost a ton of money during the bull market that started in March 2009. Hedge fund investors also paid an arm and a leg for the services that they received. We have been tracking the performance of hedge funds’ 15 most popular small-cap stock picks in real time since the end of August 2012. These stocks have returned 102% since then and outperformed the S&P 500 Index by around 53 percentage points (see the details here). That’s why we believe it is important to pay attention to hedge fund sentiment; we also don’t like paying huge fees.

Because of relative valuations and common macroeconomic factors,  Chinese internet stocks are more correlated than other stocks in other sectors. If one Chinese e-commerce stock such as Alibaba Group Holding Ltd (NYSE:BABA) goes up, other Chinese e-commerce stocks such as JD.Com Inc(ADR) (NASDAQ:JD), and to a lesser extent 500.com Ltd (NYSE:WBAI), tend to go up also. Because the same fundamental factors affect the three stocks’ earnings, investors who see Alibaba shares rallying will assume the underlying fundamental factors of Alibaba are doing better, and thus the underlying factors of JD.com and others must be doing better as well. This is also true to a lesser extent regarding search companies Baidu Inc (ADR) (NASDAQ:BIDU) and Qihoo 360 Technology Co Ltd (NYSE:QIHU) as well. If more people buy things on Alibaba because their incomes are stronger, the ad market will likely be healthier and Baidu and Qihoo will do better.

The key macroeconomic factor that sent the five stocks reeling in the past few quarters was slowing Chinese growth. China is struggling to grow at its historic 7% rate as it becomes wealthier. The problem can’t be solved by just lowering interest rates because it is more structural. The Chinese government is working on it, but many economic analysts think it will take a few years before China figures it out. Until that time, however, the earnings growth rates of many Chinese internet companies will not be as healthy as they could be if the macroeconomic conditions were better.

The market is buying today because the sentiment around future Chinese growth is improving. The Shanghai index has stabilized and seems to be on an upward trend again. Investors are inferring from the rising Shanghai index that Chinese growth will be stronger than previous dour expectations. If Chinese growth is stronger, the top and bottom lines of Chinese internet stocks will be better too.

On the next page, we’ll analyze the hedge fund sentiment towards the leader of the Chinese pack, Alibaba.

Many hedge funds still own Alibaba. According to our extensive database of around 730 elite funds, 85 reported owning Alibaba stakes worth $4.77 billion in the latest round of 13F filings, representing 2.30% of the company’s float. That compares to 86 funds with $5.8 billion in Alibaba holdings a quarter prior to that point. Rob Citrone‘s Discovery Capital Management owns 6.52 million shares of Alibaba, while Andreas Halvorsen’s Viking Global owns 6.04 million shares.

As it stands, many Chinese internet stocks are cheap. We wrote about Alibaba before and pointed out that it’s trading at just 20.4 times forward earnings. Given Alibaba’s moat and expected EPS growth rate of 22.8% per year for the next five years, we’re not sure why investors are so pessimistic. If Alibaba rallies because its cheap, other Chinese internet stocks will likely rally too because of the strong correlations, making all of them potentially solid long-term buys.

Disclosure: None