[I’ve just spent the last week as a guest of CLSA at their China Forum. First in Chengdu then on the road in Chengdu and Chongqing specifically taking the pulse of the local property market. Especial thanks to Ms.Nicolle Wong and her team for the property leg.]
No other place on earth has so many people getting out of bed every day determined to get rich, or die tryin’; and no other place on earth has such a focused administration doing their best to help. Forget the dull narrative of a broad economic slowdown (happening for sure); it’s an irrelevance. The pumping, thumping reality of economic development in China is that it’s about to kick up a notch; and, in the process, the next chapter of the most important economic story of all our lives is about to begin.
Goin’ down for real*
There’s fresh tangible good news to report on a broad number of fronts and I’ll summarize here the six most important areas.
[*I mean this of course as Messer’s Flo Rida and Sage understand the term]
1) Bottom up – Chinese companies are an improved and improving bunch
- Earnings are set to grow (ex-energy) 11% pa for the next two years (show me better, anywhere?)
- A five year trend of rising leverage and falling working capital trends reversed in 2014
- Valuations are still some of the lowest in the world
- Chinese companies’ dividend growth is the highest globally over the last ten years
- Lower input costs are now beginning to convert to improved margins
[These points are a direct lift from work by CLSA microstrategist Mr. Desh Peramunetilleke and his team in their May 7th report ‘Value Hunting in China’]
2) SOE Reform-ownership changes (everything)
So much talk, so little action; so far. China isn’t in the habit of stressing important parts of its economic ecosystem so don’t look for a ka-boom in this area. It seems clear though that toothless and politically neutered SASAC is about to get some teeth and its mojo back. The problem with SASAC in the past is that it wasn’t the owner of the assets under its watch. That meant it couldn’t control either the board composition or cash flows from dividends of its charges. It seems the plan now is to either shift SOE ownership either directly to SASAC or a Temasek like structure controlled by SASAC. After that, it’s anyone’s guess what’ll happen; but the important point is at last this really is goin’ down for real.
3) Top down – Monetary policy easing
Do I need to elaborate? Not only has China cut interest rates and pumped money into the system via Reserve Requirement Ratio cuts it’s provided some very material assistance (see below) to the property sector. No one can predict the future but it seems highly likely that the US will raise interest rates several times in the next 18-months. China, on the other hand, will not only be going the other way, it’ll also almost certainly continue in the same direction for some time. I know where my bread’s better buttered.
4) Property – As you were
I’ll follow up with a separate note on this in the next few days. The brief summary though is that (at least in Chongqing and Chengdu but I bet the pattern repeats nationwide) sales are surging. The Home Purchase Restriction parenthesis is over. The property market is just too important to flatten but it did need a tug on the leash. Having been brought to heel it’s again being encouraged. Mortgage premiums have been cut, down payment terms have been eased, prohibitions on multiple property ownership have been revised and all this is manifestly encouraging buyers. Better still, the response seems most keen from first timers and upgraders. Speculators are too busy perhaps frying other fish in A-share land? More anon.
5) Communist Party of China (CPC) – A New Dawn
I’ve written before about the effect that the Xi administration may have had on asset prices but I wasn’t fully aware how profoundly the CPC brand has been made over. If there were free elections tomorrow in China, a speaker noted forgetting that there are no other parties, they’d win a landslide. Wobbly logic aside the point is valid inasmuch as it highlights how in the last 18-months or so the CPC has recovered from a period of toleration by the citizenry to a positon now of respect. I can’t prove it, I can’t quantify it but it’s clear; China has a leader and an administration today that gains its praise unbought by the price of fear and that’s a very powerful position to rule from.
6) One Belt, One Road (OBOR, or how Xi Jinping got China’s groove back)
OBOR, pronounced unfortunately by most now as oh-bore, is the plan that China was lacking once the Olympic imperative had passed. The Shanghai 2010 Expo kept some momentum going but OBOR has reignited a welcome and constructive sense of national identity, purpose and destiny. Cynics have and will scoff but the plan is being coordinated at the highest level and already the Silk Road Fund and Asian Infrastructure Investment Bank have a very real U$140bn of firepower. This number is a drop in the bucket of what will be ultimately required but as a lightning rod for planning and future development the scheme will provide a much needed focus for future infrastructure development and is, IMHO, pure genius.
Harnessing the Chinese consumer – Good luck!
You can’t go to a gabfest in China and not hear a lot about consumption. I’m not overly interested from an investing point of view but from a general interest perspective the space is fascinating and I know many will appreciate a brief roundup. Three themes dominated the presentations.
1) Local brands rising
Foreign brands ripped into China a while back because the incumbents were so awful. Yunnan Baiyao’s herbal toothpaste though has been gaining market share for the last couple of years despite costing nearly twice as much as P+G’s alternative. Blue Moon washing detergent from a Guangzhou startup has been similarly disruptive in its space. Much of the griping from foreign brands about sales slowdowns being economy related are believed by insiders to be a smoke screen for this phenomenon. As it was pointed out, the Chinese consumer knows that junk food is just that but when faced with a choice of their own fast food and a foreign alternative they’ll invariably now chose the domestic alternative.
2) Internet retailing
Where to begin! That it’s a runaway train isn’t news but why should this be? Nobody had a satisfactory answer but here are some clues. The domestic brick and mortar retailers of just about everything are shabby affairs so there’s little pleasure in shopping for basics. The one child policy has created a group with no siblings and anxious for friends so they spend huge amounts of time with virtual friends on line. Incumbent brands have put up only weak resistance to the internet threat and so a proliferation of new brands have been able to leapfrog what in the past may have been a multi decade brand building exercise. Whatever’s going on here the key point is it’s enormous. The only thing one can say with certainty about the space in the future is it’s sure to get much, much bigger.
3) Ridonculous competiton
The two points above seem encouraging if you’re trying to sell things in China; until you consider the competitive landscape. We learned in one presentation that China has now 100 car makers, 960 skin care brands, 424 car models, 30+ mobile phone brands (that’s not models BTW) and 1,500 beer brands. On top of the legacy-overcapacity cheap-capital SOE no-hopers in many sectors a whole new raft of players has sprung up to challenge the status quo [What ‘status quo’? Ed.]. For the consumer this is a fantasy land of almost endless choice at, literally in many cases, crazy cheap prices. For producers it’s a marketing Rubic’s cube requiring an understanding of multichannel marketing strategies, geographic product segmentation, shifting consumer preferences and fulfillment challenges across a continent. Good luck all here!
Connecticut ain’t gettin’ it
Apart from the presentations these events are a good chance to compare notes with other China nuts. I met an old acquaintance for lunch recently in Hong Kong and he noted that his head office, despite this year’s heat and light, were still mostly indifferent to China. Japan was liked, India too; but when it came to China he dryly observed ‘Connecticut ain’t gettin’ it’. Over the finger sandwiches and coffee I asked other managers whether or not their respective Connecticut’s were getting it? Almost without exception the answer was the same, ‘Not really’.
My polling was unscientific and the respondents were probably, as specialists, inclined to feel their interest should be allotted more weight. Whatever. The China markets have risen rapidly and intuitively it would make sense that large institutions that move necessarily cautiously would now find themselves underweight; and indeed this seems to be the case.
June 9th – MSCI to stop fence sitting?
There’s no mileage in going for a deep dive as to why China is underappreciated by the global institutional investment community; it just is. For the last five years many have invested heavily in China pessimism and are reluctant to let these positions go; but they may have no choice shortly.
Whilst at the Forum we learned that after (over two years?) a long consultation MSCI will make a decision, after hours NY time, on June 9th about the inclusion of A-shares into their family of indices.
I could imagine how, without the HK-Shanghai stock connect, they could put off A-share inclusion; but with the connect up, and running so successfully, I think it’ll be impossible. Pretty much any large investing institution who applies for QFII quota gets it these days. Smaller institutional investors have for years been able to effectively rent quota and now Mrs. Wang is joined by Mrs. Wong in terms of retail access.
For China haters a decision by MSCI to include A-shares into their mix (presumably only MSCI China, and there only small initially?) may provide a welcome fig-leaf of respectability for a change to long standing antipathy?
Déjà vu, all over again – Japan II?
I began my career in Asia in Japan in 1984. ‘A market of copycat manufacturers built on shaky credit run by insiders’ was how a then old Japan hand explained the Japanese stock market to me. Sound familiar? ‘Besides, foreigners have had trouble with access in the past and they’re not going to start playing on these sorts of valuations, especially in companies nobody really understands’ the summary continued. Hmm. As I’d just arrived to peddle bonds I felt very reassured about having nothing to do with that grubby dead end. Er, and we all know what happened next?
I feel on shaky ground here but I think it’s now time to be alive to the possibility of China ‘doing a Japan’. What does that mean? It means a market that moves from emerging curiosity to mainstream must-have. One of the reasons Japan had such momentum in the ‘80s was not only were domestic investors fired up but foreigners were pouring over the ramparts at the same time. Both groups trying to acquire, despite the gross market capitalization numbers, a surprisingly small free float.
There are 100-reasons that China isn’t Japan but markets rhyme and in some crucial respects there are enough reasons that China is like ‘80s Japan, from a global investors’ perspective, as to put this possibility now on the table.
Easier to grasp
Chinese companies increasingly speak a language that international investors find easy on the ear. The internet companies of course speak fluent Cupertino. Property companies are increasingly converting from a belief in volume to the church of higher ROEs. I’ve noted improved dividend payout ratios above and this trend will continue with SOE reform. Capital discipline, shareholder engagement and sustainability are no longer exceptional characteristics of Chinese companies; they’re increasingly the rule.
China itself is also easier to navigate. I wondered if it was just me standing in a Chengdu mall thinking this could be Sydney or Seattle until another investor, unprompted, said just the same thing. Easier to understand means easier to analyze, easier to appreciate and easier to have confidence about investing in.
In Conclusion
I believe China is at an inflection point and a development model that’s done a splendid job for over 30-years is being retired. I’m not the first to say it but, for the first time, I myself am fully convinced it’s happening.
This won’t change the way I think investors should address the market. Healthy skepticism and a wide margin of error will still be fundamental prerequisites for including stocks into portfolios but looking out for old bogeymen may no longer be necessary or appropriate.
Sorry, therefore, Mr. Chanos; the China property market is not Dubai times 1000, and it never was. Thanks for the heads up Ms. Chu and Fitch but Local Government Financing Vehicles and the shadow banking complex are not daggers pointed at the heart of the financial system, nor were they ever, and finally sorry Wall Street Journal (http://www.wsj.com/articles/the-coming-chinese-crack-up-1425659198) and Mr. Gordon Chang, the political system is not about to collapse in on itself.
China has never cared what doubters had to say anyway; it was, is, and will remain too busy getting rich or ready to die tryin’. Mr. Curtis Jackson (a.k.a. 50 Cent, from whose debut album the title of this note is borrowed) with grit, determination and hard work appears to have achieved his dream. I have no doubt China, a nation of over a billion similarly driven souls, will achieve theirs.
中国,万马奔腾!
[Lit. China, ten thousand horses surging forward; better perhaps China, full steam ahead!]