Is China Investable? A New Approach to a Nagging Question - for 2023
BREAKING NEWS
That white balloon was a floating flaican media’s supreme effectiveness in spinning anything the country does into either a military threat, or a sign of imminent collapse.
As a result, it’s now as hard for you to approach China objectively as it was for Chinese to think of the West objectively during the Cultural Revolution.
This is not to admonish, but rather point out the massive asymmetry waiting to be leveraged by a reasonably fair-minded, disciplined investor.
For on one side the world’s second largest equities market hums along, still 80% retail traded by daily volume, still mandated to be a global financial hub, an engine of capital formation for China’s new economy, by a government who, whatever else, is very serious about hitting its long-term targets.
And on the other side: a legacy media raises alarms, mandated to help contain China with its ongoing messaging.
BUT ON TO THE QUESTION
It’s annoying to ask customer support reps a question, only to get questioned back. “Did you restart the machine, sir?” Annoying, but necessary.
Is China investable?
-Do you mean Chinese companies listed in the U.S.? (most investors do) Sure, many golden dragons are still trading at close to liquidation value. But those stocks are most vulnerable to the existential threat of America’s containment-driven policies and China’s willingness to play ball.
-Do you mean buying ETFs? Only if ongoing volatility is factored into your approach. Chinese monetary policy is not designed to ensure buybacks and soaring CAGR. So the CSI300 will not soon be the S&P 500. Then again, the S&P was down 20% in 2022, and optimists will be happy with 4200 by year end. Keep in mind both Vanguard and Schwab are recommending international stocks over U.S. equities. They’re not referring to the LSE.
-Do you mean setting up shop in China and managing your own portfolio? Bold and visionary for non-bulge bracket shops - and honestly, impractical. All the risks concerning opaque regulatory moves and arduous due diligence grow salient in this scenario. Recruiting and keeping local talent will be a time-consuming challenge in its own right.
How is China most investable?
Through active management. As we bid adieu to the golden age of cheap money with modest inflation, and the Fed finds it harder to make hedge funds look foolish, and indexes common sense, it’s going to become ever more compelling to consider paying 2 & 20 for outperformance.
That 2 & 20 goes a lot further in China. The mainland’s top 100 investment shops have deep benches of former bulge bracket pros who saw greener pastures and bluer oceans back home, and came back to conquer. Quant, value, contrarian, the styles and strategies are as diverse as the outperformance is consistent.
At the risk of withering their well-deserved laurels, one dominant theme must be pointed out: these top mainland funds are Mavericks, Lakers, and Celtics playing on what is still essentially a pick-up lot, even if it is the world’s second largest.
WE STILL HAVE QUESTIONS
On to those burning objections to China’s macro-climate that must be addressed. Kindly keep in mind that mainland fund managers do not share the alarm westerners have towards the factors behind those objections.
Instead, much like an experienced pilot, for whom the prospects of turbulence and landing are well-managed processes, but disastrous for a novice flier, such managers have those factors baked into their operations.
Thus we address the macro questions here, not so much to convert the China skeptic as to smooth the path for consultation with mainland managers who want to discuss their latest AI-driven trend signals, rather than when China will invade Taiwan.
So when will China invade Taiwan?
An appeal to a different authority: our founding partner and CIO, Allen Kuo, is also an executive president at China conglomerate Fosun, a long-time resident of Shanghai, and a citizen of Taiwan.
Says Allen, “For investment professionals on the mainland, the consensus is that a ‘hot war’ with America would be economically disastrous, with no clear advantage to victory other than a symbolic one. We believe China’s leadership is also strategic enough to realize this, and as much as possible will avoid a war, while trying to save face and project growing military capability.”
As to the attendant risk, Allen says, “In today’s investment climate, the best way to avoid risk is a Swiss bank account. Of course, the sophisticated investor’s approach is how to price risk. We look at pricing and managing China risk well, as a benchmark for the funds we work with, all of whom boast robust research, liquidity controls, value factors, a whole playbook that’s been working in China for years.”
Increasing government centralization and rhetoric mean growth and development have taken a back seat to political power consolidation, don’t they?
Quite the contrary, paradoxical though it may seem. Consider the following quote from this media brief on the guiding principles of last year’s 20th CPC National Congress:
On July 1, 2021, General Secretary Xi Jinping declared on behalf of the Party and the people that through the continued efforts of the whole Party and the entire nation, we have realized the first centenary goal of building a moderately prosperous society in all respects.
Building China into a modern socialist country in all respects is the Second Centenary Goal of the CPC. To this end, a two-step strategic plan has been adopted: basically realizing socialist modernization from 2020 through 2035; and building China into a great modern socialist country that is prosperous, strong, democratic, culturally advanced, harmonious, and beautiful from 2035 through the middle of this century when China will celebrate the 100th anniversary of its founding.
Yes, the word “strong” was mentioned, but then so was “democratic”. Note well that “prosperous” came first, and consider two statistics:
1. Per JP Morgan, by the end of this year 51% of China will be middle class (which starts at $7,250/year). Japan stands at 65%; the OECD average is 61%.
2. China’s TFP (total factor productivity) is roughly 40% of the American level.
Bringing another 15% of China into the middle class to match Japan’s levels speaks much more to China’s ideas of national rejuvenation than being involved on as many military fronts as America is.
It also puts President Xi’s shibboleth “common prosperity” in perspective: not a Marxist scheme for wealth re-distribution, but an expansion of the middle class, and likewise the domestic consumption so critical to balancing out its over-reliance on exports.
As to TFP, in order for China to double its GDP again by 2035, the Bank of Japan says “To overcome obstacles and proceed with catch-up, China will need to boost TFP growth by promoting innovation and making steady progress in addressing institutional and resource allocation issues.”
Which of the following seem a better approach for China to address those “institutional and resource allocation issues” – moving up the industrial value chain and increasing economic cooperation, or playing the role of increasingly dictatorial, aspiring hegemon that Fox News ascribes to it?
Hey, do you guys still have COVID? What happens if it comes back?
Even the begrudging Bloomberg has described China as having herd immunity to COVID-19. Even if that turns out to not be the case, and another wave of pandemic manifests, the protests and rapid cancellation of lockdown policy in response to them was a watershed event, if little reflected on.
We view it as highly significant that the government responded with quick and sweeping action to the spate of protests, and view it as highly unlikely that it would reverse course and reinstitute extensive lockdowns were a pandemic to reoccur. Hopefully the lack of military response, or further protests once those policies were revoked, will serve to calibrate investors’ views on the extent of the authoritarianism ascribed to the CPC.
China’s aging and shrinking demographics will eventually collapse the economy, right?
Gordon Chang advised of China’s demographic peril in 2001. The return of this narrative, following the failure of the 3 Gorges Dam, 2015 stock crisis, tech crackdowns, or Evergrande’s crash to collapse China’s economy, leads us to believe that this demographic ‘crisis’ is a filler narrative until something more substantial heralding China’s collapse appears.
The question is if China is growing old faster than it is growing rich enough for the increase in spending on senior entitlements, and innovative enough to increase productivity to the point that the dwindling number joining the labor force can be offset.
One may point out that Americans over 65 are 17% of the population to China’s 11%, or Japan’s comparably low fertility rate, yet both these countries became advanced first world economies before facing these challenges. Still, given their debt levels and other economic challenges, it would be biased to assume demographic issues will have a larger or more negative impact on China than on America or Japan (or Germany), and ultimately unreliable from as an investment theme, given the number of unwieldy inputs.