Regulatory Crackdown And Zero Covid Policy And Investors Are Fleeing, Others Are Piling In!
“The Gem cannot be polished without friction…”
China has been gracious, extremely friendly with Mauritius with the implementation of the historic Mauritius-China Free Trade Agreement (“FTA”); a first of its kind with an African country. Above all for Mauritius, this agreement is a boost to our positioning as a true economic bridge linking Asia to Africa. It comes at a time when our country is crossing swords with the United Kingdom and its powerful ally, the United States of America. I don’t know if the enemy of your enemy is my friend, but China’s geopolitical strategy in Africa, including Mauritius, has been well thought out and effectively executed so far. Their ‘Belt & Road’ initiative crossing Asia/Russia/Europe and their geopolitical influence linking all of Asia through Afghanistan (now that the Americans are gone?) With the trade wars with the Trump administration not fully subsiding this year, we note the pandemic threatening slowdown of the Chinese economy and a carefully ‘planned’ crackdown on its tech giants; this, in the midst of an ongoing ‘tech’ war with the Americans! And what about the Chinese markets in all this?
“With China, it is crucial to understand the game within the game…”
Empirical research is critical in investment decisions.
A global research firm such as Gavekal Research (https://web.gavekal.com); with a strong field presence in Beijing and headquarters in Hong Kong, provides us, the institutional investors, with consistent and empirical information on this increasingly complex but attractive market; which, among other things, enables us to make risk-adjusted investment decisions for our valued clients.
The ring chart below clearly depicts the performance of the broader Chinese stock market, indexed by the MSCI China Index. It is worth noting the highly volatile years of the “US-China trade war” were followed by a highly divergent performance (relative to global stock markets and particularly the US) as the pandemic hit the world. However, since peaking on February 17, 2021, Chinese markets have plunged by about -30%; losing its previous gains and thus bringing it back to its June 2020 levels.
Discount, they say? Should you buy into this downturn? Does the Chinese market still make sense at current levels?
“Understanding the Global Geopolitical Game”
By now, our readers are aware that we now live in a world where a global superpower (the United States) is beginning to seriously feel the economic and geopolitical threat of a future superpower, China. As history and the law of nature repeat themselves, all empires eventually ‘collapse’ (some sooner, some later than their predecessors). This is the natural evolution that is embedded in the very fabric of our cosmos, and by extension, in our global geopolitical and socio-economic systems.
Notwithstanding a major global calamity and/or other geopolitical delaying tactics on the part of the United States, the rise of the Chinese empire, as a global superpower, by 2035/40 is mathematically almost certain. Most important, however, will be the clash between democratic and semi-communist/capitalist socio-economic models. Why the term socio-, well, superpowers affect societies culturally: Unless we are still living in Plato’s great cave, it is empirically palpable! The more one researches, the more one begins to notice fundamental differences, which obviously can be terribly nuanced!
While the geopolitical and socio-economic strategies of the Western world are often (for centuries) related to a game of “Chess”, for the Chinese, socio-culturally, they are related to the profoundly more complex game of “Go”. Apply these 2 geostrategic formations and you end up with an even more complex global geopolitical environment, not seen in centuries!
From our empirical reading, China has extended its “friendly” influence across the Asia-Pacific (excluding Japan and South Korea), Russia, Europe, Africa, and for a long time, Australia. For us, it has gained key allies, but more importantly, when you build an empire based on a socio-economic system that allows and requires you to think decades (sometimes centuries) ahead, long-termism is the name of the game. But more importantly, you need a vast supply (and stockpile – especially in times of global trade restrictions and war(s)) of mineral resources.
The American-Chinese technology war and the Chinese “wrong-turn”
That being said, in tomorrow’s world, we all understand the ‘game-changer’ that technology has turned out to be. Technology finally leads us to space. In the initial phases, from a military point of view, the first nations to conquer deep space technology are likely to also dominate military power on the ground. Today, in the midst of a technology war with the United States, Chinese authorities are increasingly portrayed as over-regulating their own technology giants. You don’t go to crack down on your strongest cards in the middle of a complex geopolitical war, do you?
Their so-called technological crackdown and what they call the “national service” of China’s big tech companies in order to push them to develop a self-sufficient semiconductor industry (the geopolitical vacuum left by the Americans in Afghanistan clearly opens the door to Iran, Pakistan, Russia and mighty China to huge deposits of cobalt and lithium) and to employ millions of young Chinese graduates, in all humility, relates to a rhetoric that seems to be getting weaker by the day.
Gavekal’s research, mentioned here, in a research paper titled “Drivers of Regulatory Crackdown” cleverly elaborates on Xi Jinping’s key policy themes as: “rule of law construction, which requires a comprehensive regulatory framework; dual circulation, which includes strengthening antitrust laws and improving competition; common prosperity, which is about combating inequality and social division; and family values, which expresses an official concern about procreation and education. Major Internet platforms are bearing the brunt of the crackdown as they are affected by these four policy priorities. Businesses in other sectors also face increased government intervention and regulation, but less intensely because official concerns are more narrowly focused…”
We “theoretically” agree with their view that increased government intervention is likely to lead to lower growth momentum and margin compression for Chinese high-tech firms, but the bright side, in all humility, is that this is an empirical observation from the Western world: from the West. Not necessarily in China, whose semi-communist-capitalist socio-economic system has, despite all criticism, empirically created the most disposable wealth for its people over the last 50 years (yes, even more than in the US or Europe) and lifted millions out of poverty (and at a much faster rate than in India, for example ; where the brainpower and potential are there, but in an organized Indian chaos based on a “democratic” – capitalist – socio-economic system, the widening wealth inequalities have been anything but inclusive – not just! ).
Yes, buy this dip and with a long-term perspective, in alignment with the Chinese socio-economic-cultural philosophy of long-termism
The following Oval chart not only depicts China’s remarkable stock market performance over the past 7 years, but our readers will also note that this performance is also due to significantly higher volumes (which is fundamentally always important in assessing whether the stock market, its performance, its movements, in the short or medium term are tactical in nature, or fundamentally strategic in nature) Yes, the inclusion of Chinese stocks and bonds in globally important stock and bond indices has supported these increased flows, supported by a hunt for yield resulting from a low to negative real interest rate environment in most developed countries.
As a result, while many investors have abandoned Chinese equities and fled the market, rather naturally signaling capitalists’ aversion to excessive government intervention (beyond regulation), others have bought and continue to buy into these notable lows (depending on audience opinion, they say!).
The forward price of the gain differential between, say, U.S. stocks (at about 35X) and Chinese stocks (about 17X) is compelling. Yes, a “zero Covid” policy by the Chinese (and thus the on-call closure of every airport, port, city, etc.) is clearly unrealistic today and is likely to dampen domestic consumption and productivity. However, this is a very short-term consideration; reducing Chinese GDP and underlying listed company profits by a few basis points to percentage points in FY21/22, but in the longer term, it is unlikely to be a dent (such is the size of this super-powerful giant) from a multiplier perspective.
Therefore, as we approach the key support level (see Fibonacci retracement in the chart below), volumes and buy-ins are likely to increase as the months go by. We therefore remain cautious but confident on Chinese equities but also, at these levels (please see Chinese high yield debt opportunities), sovereign and investment grade corporate bonds as reasonably attractive.
Contributed by –
Amit Bakhirta
FOUNDER & CEO, ANNEAU
ANNEAU is a financial services company authorized and regulated by the Financial Services Commission (“FSC”) in Mauritius.
*The views expressed are personal.
