Preamble
My investment thesis for China hasn’t changed much in recent years; for new readers it goes like this: China, fundamentally, is fine. Its financial institutions are, fundamentally, fine. Its political system is, fundamentally, fine. Its citizenry is, for the most part, happy with its lot and businessmen of all hues are presented with many opportunities for profitable investment. Which, altogether, is just fine.
Fine does not however share a postcode with ‘great’; but nor does it live in the same neighborhood as scary, doomed or awful. Fine’s neighbors may, from time to time, include worrisome, confusing and developing but, as annoying as these sentimental co-residents can be, they’re not safety concerns; especially considering the value proposition the neighborhood continues to offer.
Summary Conclusion
Despite a multi-year bombardment of negative prognoses by partisan pessimists China’s economy has not collapsed under the weight of an unsustainable growth model. Its banks have not foundered on the rocks of government directed lending or the implosion of an out of control shadow-banking complex and its local governments appear capable of funding themselves despite narrow and fickle revenue bases.
Companies continue to increase profits, top line economic growth progresses at a robust clip, a rebalancing is underway and although all this may not warm the hearts of perma-bears a dispassionate observer would probably describe this state of affairs as, broadly speaking, fine.
China stocks nevertheless remain priced as if calamity is around the corner and the difference between these valuations and the observed reality remains a powerful argument for engagement.
Recent data suggests improvement and, that being the case, a just-fine situation may be in the process of getting a little finer. This implies the gap between reality and perception is widening which should encourage doubters at the margin to take a fresh look.
Haters Gonna Hate
Many commentators have promoted a narrative different from mine. On the subject of markets there’ll always be a variety of views, that’s how they work; but in China’s case doom and gloom seem to have been currencies in especially abundant supply in recent years.
If there’s a Godfather of the genre it must be Mr. Gordon Chang. In 2001 Gordon wrote a book with the no-messing title ‘The Coming Collapse of China’. In it he predicted “The People’s Republic has five years, perhaps ten, before it falls.”. So that should have been 2006 or 2011 at the latest. Last I checked Gordon China was, well, still just fine.
A grand bull market kept cynics penned in until they broke free again in 2010. As the West’s problems had been bank, debt and real-estate fueled it seemed only natural to go looking for the same problems in China; and Mr. Jim Chanos did a solid job of finding all three late in 2009. At that time (presumably after positioning funds accordingly?) he informed investors that China was “Dubai times 1,000, or worse.” The property market was a debt fueled house of cards and the central government had set itself on a “Treadmill to Hell..” in terms of buying prosperity on credit; and here we are, years later and again, Jim, last time I checked both government finances and the China property market seem just , well, again fine.
Not to be outdone locally based commentators joined the party. Professor Li Daokui, then a member of the central bank’s monetary committee, in June 2010 chimed in with “The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis,..” Uh-huh. Ms. Charlene Chu, than an analyst at Fitch Ratings in Bejing, was quoted by the Economist in an article in 2012 warning “..if a tenth of the banking system’s outstanding credit turns sour over the next two years, all profits and 39% of the system’s equity will be wiped out.”. Phew! We’re jolly lucky then that didn’t happen; right Charlene?
Chinazheaddedfordisaster-clack has continued pretty much uninterrupted in recent years and rose to a fresh crescendo in the early part of this when Mr. Kyle Bass, a notoriously noisy hedge fund manager, let fly a fresh volley in a letter to investors warning Chinese banks could face losses that “..could exceed 400 percent of the U.S. banking losses incurred during the subprime crisis..”. Which, in theory, of course they could. In theory I could also be a watermelon in a parallel universe; but I’m not (I don’t think?).
Just as the Grinch found Christmas came anyway it must be disheartening for China’s Cassandras to see the object of their persistent attacks in such rude good health today?
Players Gonna Play
Let’s not here reach back 40-years to remind what a monumental job the Chinese Communist Party has done in raising the largest number of people out of poverty in the history of the world. That’d be too easy.
Let’s just look at how the Chinese economy and some larger players have, in fact despite merciless criticism, performed in the last five?
The crummy banks? Take a big dull one (that I have no interest in); Agricultural Bank of China (1288, ABC). From 2010 to 2015 here’s how some of the key indicators progressed: EPS +66%, Cost to Income Ratio -14%, shareholder’s equity +123%. A (onshore) holder since listing in July 2010 would also have received dividends of Rmb0.99 or (at today’s rate of Rmb1=H$1.16) H$1.15 (last price H$3.40). Problem loans have risen, sure, but only from 2.03% to 2.39%. Hardly a disaster and you’ll find several peers did much better.
The wobbly property companies? Again, let’s take a big household name (that I also have no interest in), China Overseas Land and Investment (0688, COLI). If you had bought this stock in January 2010, not long after Mr. Chanos was sharing his Dubai times 1,000 views, you’d have doubled your money today. You’d also have received dividends of H$3.12 (last price H$27.25) and watched your firm equity grow by nearly 250%. Oh dear; and, again, this performance is replicated or bested by many peers.
The broad economy and life in general? GDP per capita in Int’l.$ PPP terms grew by 52% over the period. High speed rail track increased by 140%, infant mortality (‘09~’14) declined by 27%, passenger vehicle sales rose by 54%, outbound tourist trips increased by 110% and life expectancy has increased by 13% (to pick just a random selection of the good news). If this is a treadmill to hell others must be asking how they get on the ride?
So, sorry Gordon, Jim, Professor Li, Charlene, Kyle and everybody else that’s predicted catastrophe for China in recent years; you’re wrong. The reality of today’s China is that it’s fine. Not great, as we’ve already acknowledged, but also not the train-wreck we’ve been warned, ad nauseam, to brace-brace! for either.
Are things now getting a little better?
Is Fine Getting Finer?
I called a hard landing for China two years ago in September 2014 [https://www.chinadream.asia/i-hate-to-be-the-one-to-say-it-but-china-is-hard-landing/] and, I believe, that prediction was broadly correct. My view then was based not on a desire to have others help lean on positions or the need to collect subscriptions. It was merely a deduction based on a simple analysis of data in the public domain, which at the time was consistent with a deteriorating economic environment.
Recently data points have been showing signs of improvement. None on its own is proof the economy is on a firmer footing but together they seem to point to a better outlook.
Specifically (and in no order)..
Trade Data – A bettering of trend has been partially masked as the data is conventionally reported in U$ terms. In local currency terms there’s been a significant improvement. In July and August exports rose by 2.9% and 6% respectively, imports fell 5.7% and rose 11%; all better outcomes than forecast.
Coal and Steel prices – From the Financial Times, September 22nd. ‘The price of premium hard coking coal has more than doubled in the past six weeks to more than $200 a tonne as supplies have dwindled..’; and steel? From the South China Morning Post, September 21st. ‘The price of the most traded form of steel on the Shanghai Futures Exchange is still a quarter higher than a year earlier,..’
Power consumption – A hot summer in part accounts for July and August demand surges but the weather alone can’t explain all of July’s 8.2% YoY rise or August’s 8.3% YoY lift. Total power consumption Jan.~Aug. is up 4.2%. So somebody(s) somewhere must be up to something they weren’t a year ago?
Industrial Output – From Xinhua on September 13th ‘Industrial output expanded 6.3 percent year on year last month, faster than the 6-percent increase for July and the 6.1 percent posted for the same period of last year, ..’ The breakdown tells us that auto, pharmaceutical and electronic manufacturing enterprises did particularly well.
Company H116 reporting – We received first hand reports recently from a medly of enterprises that not only had the first half been a steady environment to operate in but from some, notably banks, news that some trends were improving; especially, in stark contrast to forecasts, NPL formation. Adjustments to third party prognostication, where post-announcement changes were required, seemed to be mostly up.
One swallow doesn’t make a summer; but what are we to make of a small flock?
Mind The Gap
The case for China stocks presently is a twofold argument.
The first is yield. In a world where investors are scrambling for returns the fact that household-name China stocks listed in Hong Kong are offering such stand out dividend yields must surely merit more attention? For example; ABC (our above dull bank) 5.7%, too risky? How about COLI then? 2.5%. Something in the middle? Swire Steady-Eddies perhaps? 4.6%.
The second and, in my view, stronger argument is the gap between the perception of China’s prospects and the observable, just-fine, reality. If data points continue their improving trend this gap will widen and become an even more compelling investment case.
In Conclusion
Sentiment-cow-tippers have failed to have much luck, for years now, prophesying bad-stuff for China and much [If any? Ed.] of their pants-on-fire forecast bad-stuff actually turning up. Sure, the economy is no longer on the rocket to God it was perhaps ten years ago; but neither has it come close to fulfilling dire predictions made over most of those same ten years.
It’s hard for many, whether short-term stock operators or rent-seeking commentators, to make a living from steady states. The model for both is one where extremes are exploited and they offer guiding lamps through the fog; always for a fee of course.
China is no such place. Its future is uncertain, its managers in both government and industry feel their way forward with rudimentary and only recently drawn maps, it’s prone to boom and bust cycles (steel, garlic, property and etcetera) and yes, it could all end in calamity; but what’s the experience of the last 40-years? The management has shown themselves consistently smart, adaptive and flexible. Problems are dealt with (often not quickly, so?) when they arise and the ultimate goal of progressing the most prosperous society for the largest number of citizens remains front and center of all policy initiatives.
If China continues on this path, and smart money should be on it will, history will judge this an awesome achievement. To refer to the present situation as just-fine therefore doesn’t seem like a hyperbolic summary. It seems to me a fair and balanced assessment; more than can be said of the alarmist (and it should be noted again, to date wrong) assessments made by assorted axe-grinders in recent years.
To speculate that fine may progress to finer, in light of recent data developments, doesn’t feel like a big reach either. For investors, the risk of factoring this shift into investment decisions is especially low given the near fire-sale valuations that continue to be on offer in many Hong Kong listed China stocks.
_______________________________________________________________________
[In this note I’ve purposely avoided the subject of debt in China. This is the under-bed-monster du jour but like the issue of Local Government Financing Vehicles (LGFVs, remember them?), the Trust Lending business, Ghost Cities, infrastructure overbuild and etcetera I believe it’ll cease to be a talking point in year or two. Because? On closer inspection it’s just one more thing in China that’s, actually and mostly, just-fine.]