It may never be truly safe to invest in Chinese equities again.
I realize that sounds hyperbolic. And it is in at least one respect. At some point, “COVID zero” will have to be jettisoned, unless the Party intends to accept intermittent lockdowns as a fact of economic life in perpetuity. Presumably, that isn’t the plan. If it is the plan, it’s a very bad one.
Once the government stops conceptualizing of the virus as something that can be contained and managed, one source of drag on local shares will fade away.
But capricious regulatory policy isn’t going away. Ever. Alibaba plunged Monday (figure below), and Tencent dropped sharply after China’s State Administration for Market Regulation hit to the two tech behemoths with new fines tied to improper reporting of past deals.
The Hang Seng Tech index, the poster child for Xi’s regulatory crackdown, fell 4%.
To be sure, those declines aren’t singularly harrowing. The point isn’t to suggest Monday was some manner of watershed session. In fact, the point is to note that days like Monday are all too common. Every few weeks, markets get another reminder that there’s no such thing as “out of the woods” when it comes to large platform companies and Xi’s efforts to bring them to heel.
With the (obvious) caveat that Xi’s autocratic approach to… well, to everything, isn’t something Western leaders should seek to emulate, there’s a sense in which he’s accepted a reality that the rest of us refuse to concede. Mega-cap tech — from Google to Alibaba, from Facebook to Tencent, from Amazon to Meituan — employs monopolistic practices. So, they’re monopolies. Maybe not in the kind of strict legal sense that would make it possible for the US to break up America’s tech giants without a protracted court battle, but certainly in a kind of common sense way. And common sense is all someone like Xi needs. He isn’t constrained in the capacity to demand restitution. No court can overrule him. The companies are helpless.
If investors understand that risk and truly accept it, then there’s an investment case for Chinese mega-cap tech. But too many China bulls attempt to make the case based on the idea (implicit or explicit) that “the crackdown,” always couched in terms that suggest it’s a discrete event, is either over or will be soon. But it’s not a discrete event. It’s an ongoing quest to prevent big-tech from acquiring too much power, and it’s never going to be “over.” Never, as long as he’s alive, will Xi be finished with these companies.
Unlike ineffectual US politicians and inept regulators, Xi doesn’t accept the notion that tech companies must be allowed to accumulate unchecked power through various means as the inevitable cost of innovation. Jeff Bezos gets to lampoon Joe Biden on Twitter with impunity. As of October 2020, Jack Ma thought he was similarly situated vis-à-vis the Party. He’s scarcely been heard from since.
Again, I should emphasize that I’m not advocating Xi’s approach to reining in big-tech, but what I am suggesting is that Xi sees things clearly as opposed to through the distorted lens of hyper-capitalism. That has serious implications for the investment thesis around Chinese equities. In the simplest possible terms: There’s only one determinant of stock performance. It’s Xi. That doesn’t mean other factors won’t take precedence from time to time when he’s preoccupied with other, more pressing matters. It just means that on any given day, he can, and will, override every single other determinant. And there isn’t a thing in the world investors (big, small or otherwise) can do about it.
The same goes for China’s COVID containment policy. Macau’s casinos were shuttered for a week, prompting a large drop in related shares traded in Hong Kong and now there’s another outbreak in Shanghai, where Omicron sub-variants are driving up new infections.
H-shares have logged just a single gain in eight days on the heels of an impressive rally from local lows (figure above). On the Mainland, the CSI 300 looks set to cool after outperforming most global benchmarks amid reopening optimism and a widening policy divergence between China and the rest of the world.
Shanghai had dozens of new COVID cases on Sunday, and that’s in addition to flareups in other parts of the country. More lockdowns are a matter of “when,” not “if.”
The difference between China’s tech titans and COVID is that Xi can control the former, but not the latter. He doesn’t recognize the distinction, though, which means Beijing’s efforts to curb the virus will continue to resemble its efforts to curb big-tech. Whenever there’s evidence of insubordination, either on the part of capital or COVID, Xi will engage in an iron-fisted crackdown. The interests of investors aren’t just secondary, they’re irrelevant.
The Covid lockdowns may end when he has fully consolidated power. Whispered conversations in convention centers can’t happen if it’s all monitored online. Drilling and practicing for war time population control.
Meanwhile CNN.com ran this story…
“China crushes mass protest by bank depositors demanding their life savings back”
We’ve seen this coming for a long time, and it’s a very sad thing for the Chinese people. I recall Xi restricting travel in and out of Hong Kong as an early example of his destructive actions. But not unlike Putin in Russia, Xi is hurting himself and his country and doesn’t perceive it because he has authoritarian needs to satisfy. And the timing is right because Xi is comfortable in his power. He has the second largest economy in the world and vast financial resources, thanks to the great opening of China in the twentieth century to capitalist business practices, and the West’s investments in his country. But he has other things on his mind at the moment. Now he pursues other goals, such as taking Taiwan while the West is engaged in supporting the Ukraine in Eastern Europe. I reckon Xi is going to call Biden’s bluff on Taiwan.
I really have a hard time with American companies that do not speak, either through actions or words, in reaction to Chinese autocratic policies. I’m also afraid that the broad group of corporate and national leaders in western countries are not clearly imagining the possibility that we are inching closer to World War III. That’s not a place I want to go in my thinking either. But China has not been in a hot war since Korea. Russia-Ukraine is already on the table. If the Chinese want to express the substantial power they have built in their military, we are all going to have a problem. In addition, American companies operating in China will have to deal with the Chinese beast.
Funny thing – I always thought US companies valued risk management practices. But that doesn’t seem (to me) to be the case in China.
I had BABA TCEHY BIDU in portfolios from about 2016, sold in late 2020, was thinking about getting back in, but upon inspection it seems to have to assume these are MSD% growers with limited ability to enter new markets, a cap on margins, periodic cash calls from the CCP, and a persistent Xi overhang, Plugging those into the models, the names don’t look so great. I think smaller, less notable names in the CCP-favored sectors (semis, biotech, etc) could be fruitful, but the local knowledge required for that sort of picking is hard to come by. Maybe an ETF / fund focused on A-shares, or hard tech sector.
I have a small-cap fin-tech, QFIN, that has good promise. It has huge cashflow and margins, and I expect it to be profitable in the near term. But even with that, the cold-water impact of Xi’s recent pattern of behavior, combined with the broader macro issues here in the US inspire some doubt. I’m keeping my ear on the rail, listening for the Xi choo-choo to roll around the turn in the tracks. But I don’t think it will actually impact my small-cap stock.
One more note to add in this discussion about investing in China… The weaker rate of growth this year due to lower infrastructure spending, Covid lockdowns, and general mismanagement is expected to have severe consequences this year for small banks in China. I’ve seen more news recently about Chinese banks running out of money. Here are some links from articles in recent days:
https://www.youtube.com/watch?v=NA1h9raxCs8
https://www.youtube.com/watch?v=cVMR39MfkJY&t=198s
This does not portend a financial disaster of some kind. But it is some egg on the face of the government, which runs the economy.
One might expect the government to paper over the bad publicity lately about Chinese banks, whether large or small, and publish some excuses about “one-off” disruptions to a few isolated financial services businesses due to mishandling of balance sheets in some small banks. But it seems they’ll need to do more than paper over the problem in the longer term.
Xi is using covid, tech titans, Hong Kong, Taiwan, etc. all as excuses to keep the 1.4B Chinese people under his thumb in his authoritarian dictatorship.
He absolutely will keep the Chinese equities in a tight range- not so low that the population comes after him because they have nothing, but not too high, either. A population that starts to feel a bit wealthy might not want to do as he tells them to do.