Do you know the ‘China’ story?

Hello monkeys - Over the last three years, I have observed an enormous increase in the attention paid, both by sell-side and buy-side, to developments in China. One post does not do justice to the topic but hopefully this can get you started in forming a macro view on China:

On April 20th, 2014, Forbes carried an article suggesting that Li Ka-Shing, the 'Superman' of Hong Kong and 'China's Warren Buffet', is moving out of China which may indicate an early warning of an imminent slowdown. Meanwhile, the real Warren Buffet has, very famously, said:

The 19th century belonged to England, the 20th century belonged to the U.S., and the 21st century belongs to China. Invest accordingly

So what of China? The investment community can be split into two diametrically opposite camps on the future of China. The bulls argue that China is on the cusp of breaking out as the world's biggest superpower, as it had been for centuries before the Opium War. They point to long term bullish factors such as urbanization and a surge in consumer demand over the next few decades. The bears point to dangers of excessive corporate debt, inefficient State Owned Enterprises and long term structural declines from an ageing population. China's 'Hard Landing' is a popular topic in the latter camp.

At the heart of the issue lies interest rates and financial repression. Ever since Deng Xiaoping led China through a thirty year economic boom that brought the country to the global centre stage, interest rates have been artificially suppressed to promote the manufacturing/export sector and the banks at the expense of the household sector/ordinary citizens. Cheap labour costs and the PBOC's massive purchase of incoming US$ to maintain a competitive exchange rate, helped China to emerge, until 2008, as a champion exporter of everything from toys to electronic devices. This export machine fueled the country's GDP but GDP growth, in itself, became a target for the Party. With global demand for China's exports contracting as a result of the 2008 credit crisis, the shortfall in China's GDP growth target was compensated by investment (or over-investment as the bears would call it) in infrastructure and property. Repressed interest rates and volatile stock markets also meant that households had few avenues to deploy their meagre savings apart from real estate. This collective zeal led to some ghost cities, which spooked the western media leading to your customary bearish FT and WSJ articles on the upcoming 'China Hard Landing'.

Indeed, the famous hard landing never arrived but real GDP growth has slowed down materially from 10%yoy+ pre crisis to 7.4%yoy in 2014. So the absence of 'hard landing' has not entirely vindicated the bulls. The other 'success' that bears point to is the dismal long term performance of China's stock markets (atleast until the last four months) - both A shares and H shares, when compared with the country's GDP. This leads some extreme bears to declare that China's GDP growth is a man-made fiction - a view that Wikileaks claims has been corroborated by the country's current premier back in 2007. The bulls argue that China's stock markets are massively undervalued and offer the most significant investment returns as P/E ratios rerate, when the bearish sentiment inevitably subsides (as it seems to have following the launch of Shanghai-Hong Kong stock-connect).

China Property remains at the centre of this debate. The recent slowdown in property prices, collapse in national sales and property investments and the hurried relaxation of Housing Purchase Restrictions (HPRs) in a slew of cities, together with the easing (both fiscal and monetary) carried out by regulators, suggests that the debate may be close to an inflection point within the next couple of years.

Take your pick on which side you will put your money: Chinese stocks are up more than 40% in the last four months. Irrespective of the eventual outcome, China will likely represent the most significant case study in economic planning for business students in the twenty-first century.

Comments (19)

Feb 27, 2015

That sounds wonderful. I have been investing in China's stock market from 2009 to the present and I am glad the stock is going up now--great time for me to sell 90% of my holdings and invest somewhere else. The idea of investing in China may sound amazing, but beware of the risks. Would you invest in something you don't understand (other than what you hear from news, etc.)?

Never let success go into your head and failure go into your heart.

Feb 27, 2015

The Chinese century ended around 2011 - 12. The momentum of its previous growth is carrying it forward for now.

Your China story is the bland 'analysis' that has been floating around for at least the last 2 years.

I'm waiting for when the CPC Central Committee announces that it will start large scale privatisation of SOEs - most likely around the 20th National Congress. That will be a post-Soviet Russia style sell off of SOEs on the cheap to party officials.

How much faith does the average CCP official have in the future of China?

Around 2 houses in Vancouver/Sydney/New York plus a wife and 1 child with foreign passport of faith.

    • 1
Feb 27, 2015
SSits:

Your China story is the bland 'analysis' that has been floating around for at least the last 2 years.

The purpose of this post is to help people get started in forming a macro view on China and is therefore not meant to be an in-depth analysis. I have personally talked to more than 100 buy-side investors so far and you'd be surprised at how many of them do not know even the very basic story that i have presented here. I am happy to do an in-depth post on SOE reforms, shadow banking, political structure, China property or anything else that readers are interested in but I suspect that most WSO readers would benefit more from an introduction.

AnonymousJoe:

Would you invest in something you don't understand (other than what you hear from news, etc.)?

I work at a sellside S&T shop and focus on Asia (a big part of which is China) and even with this vantage point, I have to confess that I understand very little about China. At the same time, you have to admit that Chinese securities (equity or fixed income) have historically traded cheap if (and a very big IF) you believed the numbers. The media (FT for instance) has been consistently bearish on China but things may not be as bad as they are made out to be. China is the biggest trading partner of Brazil, Chile and Peru which are right next door to the US. Of course bears may argue that this is all part of China's investment/global commodity boom that will end in tears.

Feb 27, 2015
Stalagmite:

personally talked to more than 100 buy-side investors

Unnecessary adverb "personally"; sellside talk. Bad habit. Does anyone talk to people impersonally?

You'll have more credibility with the buy side if you avoid that marketing fluff talk.

Mar 3, 2015
SSits:

How much faith does the average CCP official have in the future of China?

Around 2 houses in Vancouver/Sydney/New York plus a wife and 1 child with foreign passport of faith.

lol... true dat

WSO's COO (Chief Operating Orangutan) | My Linkedin

Mar 3, 2015

Another example of the faith that the average **cashed-up** middle class Chinese family has in the fate of China: http://www.latimes.com/local/lanow/la-me-ln-birth-...

LATimes:

Another soon-to-be mother who asked to be identified by her last name, Wu, said she came to the U.S. from the Hunan region of China in December. She said that while she understood that the practice of birth tourism was controversial, she wants her child to have a future.

"If things were good in China, why would we need to come here?" said Wu, who also declined to say which agency arranged her trip.

...

In a few weeks, Wu said, she will have a daughter. With American citizenship, her daughter will have "very big, very happy" future, she said.

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Feb 27, 2015

Interesting. Can you do another post on Chinese shadow banks and the debt situation there? It would make a good follow up to this.

Use more debt than your competition or get out of the business. Any other policy is either self-limiting, no-win, or a bet that the competition will go bankrupt before they displace you. - Bruce Henderson

Feb 28, 2015
ghettobanker:

Interesting. Can you do another post on Chinese shadow banks and the debt situation there? It would make a good follow up to this.

Thanks, that's a good idea

Mar 2, 2015
ghettobanker:

Interesting. Can you do another post on Chinese shadow banks and the debt situation there? It would make a good follow up to this.

+1

Apr 7, 2015
chiclanda:
ghettobanker wrote:

Interesting. Can you do another post on Chinese shadow banks and the debt situation there? It would make a good follow up to this.

+1

Hi, I have written a post on Chinese shadow banking if you are interested:
http://www.wallstreetoasis.com/blog/an-introductio...

Apr 7, 2015
ghettobanker:

Interesting. Can you do another post on Chinese shadow banks and the debt situation there? It would make a good follow up to this.

Hi, I have written a post on Chinese shadow banking if you are interested:

http://www.wallstreetoasis.com/blog/an-introductio...

Apr 9, 2015

Cool, thanks. Will bookmark for reading later.

Use more debt than your competition or get out of the business. Any other policy is either self-limiting, no-win, or a bet that the competition will go bankrupt before they displace you. - Bruce Henderson

Feb 28, 2015

My issue with China is that it's not like investing in any other country, ever. There's a political and social risk that is often overlooked: we're looking at a country with the largest transition from poor rural to what some would like to call middle class/income and they will start to see what they never thought possible to what they now see as possible. When dirt poor peasants see that their cousin has a tv because they work at a company in Shenzen that makes our iphones (and cousin's life actually sucks because their life isn't much better than an indentured servant) that can easily unlock a belief that they actually can have a better life with stuff and could lead to significant social upheavel. That's not good for the US but I can't help but see another Tiananmen Sq actually lead to revolution. They can only censor the media for so long and once that barrier has been breached it's tough to pull it back.

Feb 28, 2015
Dingdong08:

My issue with China is that it's not like investing in any other country, ever. There's a political and social risk that is often overlooked: we're looking at a country with the largest transition from poor rural to what some would like to call middle class/income and they will start to see what they never thought possible to what they now see as possible. When dirt poor peasants see that their cousin has a tv because they work at a company in Shenzen that makes our iphones (and cousin's life actually sucks because their life isn't much better than an indentured servant) that can easily unlock a belief that they actually can have a better life with stuff and could lead to significant social upheavel. That's not good for the US but I can't help but see another Tiananmen Sq actually lead to revolution. They can only censor the media for so long and once that barrier has been breached it's tough to pull it back.

Personally, I agree with you on political risk but perhaps less so on social risk. Inexperienced investors are often surprised when they learn that outward trappings of the Chinese government are a facade and the real political power lies in the Party hierarchy. For instance, Xi Jinping derives his authority not from being the president of the PRC (the head of state) but from being the General Secretary of the Chinese communist party (and the chairman of the Central Military Commission). The People's Liberation Army is not an army representing the Chinese citizens but the armed wing of the Party. This may sound irrelevant but is quite important for foreign investors because decisions may sometimes be taken at a level that few investors knew existed. Sanlu's actions during the 2008 Chinese milk scandal represent a very good case study on how irrelevant a company's board can become when confronted with the Party's priorities. The New Zealand dairy giant Fonterra (which owned a 43% stake in Sanlu) was aware of the contamination a month before the public recall. Fonterra's version of the story is that they pushed hard for a recall but were overruled by the local administrators (who may have been influenced by the negative publicity such a recall would generate during the Beijing Olympics). If Fonterra felt powerless in such a crisis situation, then minority investors likely face much higher political risk.
The reason why I agree less on social risk is because, as I mentioned, the PLA is not avowed to the Chinese citizens but to the Party - their loyalty was tested in 1989 and they came out, from the Party's perspective, with flying colours. I think the Chinese citizens are aware of this, which is why I am not in the camp of social upheavals - although that is certainly a risk.

Feb 28, 2015

As someone clearly in the know, how do you view Chinese commodity demand (steel, copper) going forward?

Personally of the view that per capita consumption should normalize to historical levels in mid-developed societies (China has been an outlier to the upside) as the party realizes a consumption led economic is not only the logical next step, but the only one.

Feb 28, 2015
Semi-Socratic:

As someone clearly in the know, how do you view Chinese commodity demand (steel, copper) going forward?

Personally of the view that per capita consumption should normalize to historical levels in mid-developed societies (China has been an outlier to the upside) as the party realizes a consumption led economic is not only the logical next step, but the only one.

I am not an expert on commodities but if I have to make a guess, I would agree with you. The demand for steel and copper in China is dependant on China's property market (infrastructure is the other source of demand but most infrastructure spending is done by local governments who depend on land sales for close to a third of their revenue which brings us back to China property). China's property market entered a slowdown in 2014 and even optimists would admit that an upturn will not occur before the end of 2015. Pessimists may argue that we will not reach 20-30% sales growth ever. As a result, I will not be bullish on chinese demand for steel and copper

Feb 28, 2015

It looks like China has the potential to face big swings in industrial output in the coming decades, the type you saw in Industrial Revolution Europe and USA. However, China and infamous CCP have studied the nations which went through these economic eras, they are not in uncharted territory, unlike 19th century Europe and America. As long as the CCP manages to steer away from micro-politics and ideological ankyloses, they can evolve into a "Commission of Wise-men" type of role which will be massively beneficial.

Colourful TV, colourless Life.

Feb 28, 2015
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