Chinese Equities
The Chinese economy has been in the doldrums ever since its Covid policy response. However, this pales compared to the financial markets and asset prices more broadly. It depends upon which market or region you look at but broadly speaking Chinese property is down 30% and Chinese shares were down 60%. This compares to the US where the stock market is at all-time highs and property is buoyant. Until now, Chinese policy has not been shifted to address these issues. While Western Governments were handing out money willy nilly in response to Covid, China not only enforced the most stringent lockdowns, but they also left the population to deal with the financial consequences on their own.
On 24th September, the People’s Bank of China (PBOC) cut interest rates, lowered banks’ reserve requirements and took steps to reduce mortgage payments. More critically, the central bank will help firms buy back their own shares by refinancing bank loans used for that purpose. It will also help securities companies, insurers and other institutional investors raise funds, making their balance sheets more robust. Two days later the Chinese Communist Party (CCP) resolved to address the property market’s decline and implement aggressive counter-cyclical policies.
Chinese equities which had been significantly under-performing both developed and other emerging market equity markets took off like a rocket, with major indices rallying 30% in a matter of a few days. When Chinese equities were under-performing, the job of a global equity portfolio manager was simple. Avoid Chinese stocks like the plague. The evolution of the “great power conflict” between the US (and Western democracies more broadly) and China, combined with the terrible performance has earned China the moniker “uninvestable”. The often-cited example as the reason for this is what happened to Russian assets in the wake of the Ukraine invasion. However, now there is a genuine catalyst that will cause investors to question whether this is the right position to take. It’s much easier to look down your nose at something that is going down.
As you might expect there is no consensus on what this means. For example, legendary investor David Tepper of Appaloosa Management, a hedge fund, in an interview with CNBC was asked what he would buy, he replied, “Everything. Every. Thing.” Others have been much more circumspect. The argument of the naysayers is broadly split into two categories. First, you can’t trust the property rights in China and even if you think you own something, eventually if will be taken away. Second, the economy is terminally in decline due to structural factors such as
debt, demographics and fundamental problems with the communist model and the stimulus will never be enough to change that.
Whilst we have sympathy with both these lines of argument, our retort would be that “that doesn’t mean Chinese shares can’t go up a lot in the meantime”. It doesn’t mean that policy announcements won’t disappoint along the way and that Chinese shares won’t sell-off dramatically as a result. They will. However, we do think that the recent announcements represent a line in the sand or “policy bottom” where the CCP now actively wants shares to go up whereas in the past they wanted them to go down. If the agenda at the latest Politburo meeting is 1. Make shares go up. AOB, we think there is a good chance that over time they will get their wish. They have plenty of levers to pull and the fact they have not pulled them until now has been a choice. To those who say this won’t help the economy, we say you may be absolutely correct. However, we think the policy to stimulate the economy is via higher asset prices not the other way around.
This is a much tougher trade for investors to get right than piling into US tech names when judged against a global benchmark. Valuations in the most efficient industrial economy in the world are on their knees and global investor positioning could not be more bearish. The pain trade is higher.