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Chinese equities are up 25% for November and high profile fund managers are investing again

Investing in China is a decision to weigh up carefully. But after over a year of steep falls for Chinese equities between…
The post Chinese equities…

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Investing in China is a decision to weigh up carefully. But after over a year of steep falls for Chinese equities between July 2021 and late October this year, high-profile fund managers are putting their faith, and money, back into the world’s most populous country.

This week Bloomberg reported that two veteran fund managers, Franklin Templeton’s Manraj Sekhon and Bill Maldonado, CIO at Singapore’s Eastspring Investments, have joined a growing list of asset managers buying up Chinese equities. The bet is Beijing moves away from the Covid Zero policy that has disrupted supply chains since 2020 by reducing China’s manufacturing output and the broader economy.

Source: Yahoo Finance

The change in market sentiment towards China by international money managers has seen the MSCI China index gain almost 25% over November so far. The MSCI World index is up just 5% over the same period.

Maldonado reasoned, in the wake of his decision to invest in China again:

“The worst is already priced in and you’ve got plenty of upside. You’d be buying now and expecting things to kind of rebound on a three-to-six-month basis.”

Templeton’s Sekhon was even more directly bullish, commenting “it’s time to get involved in China if you haven’t already.” 

But Chinese equities are still viewed as an exotic and risky market by most retail investors and one relatively few are exposed to. There are good reasons to view Chinese equities as risky, not least as evidenced by the market’s recent 60%+ slump. But that doesn’t mean they don’t hold plenty of potential too, especially at current price levels and after what looks like it might be the start of a strong market recovery taking hold this month.

For investors who might want to take Franklin Templeton’s Sekhon at his word and “get involved in China”, what are the risks to consider and the factors that also mean a growing number of experienced fund managers see them as worth taking?

The risks posed by investing in China

Geopolitical tensions between China and the West, centred around Taiwan but extending to a struggle for power, influence and access to natural resources and trade corridors in South East Asia, the Pacific, Africa and elsewhere, will be a risk for the foreseeable future.

There’s also the risk of the trade war between the USA and China stoked during the Trump presidency of the former reigniting. That was highlighted this week when Trump announced his candidacy to run for the Republican nomination for the 2024 presidential election.

Is Beijing’s domestic policy as big a risk as potential geopolitical flashpoints?

Internal politics are a further risk to investing in China. The MSCI China index slumped by over 60% between early July 2021 and a recent low on October 23 this year and that precipitous drop was caused by a number of factors closely related to Beijing’s domestic policy.

The first was the bursting of the country’s housing bubble and loss of faith in the financial strength of construction companies following the well-publicised collapse into receivership of Evergrande, the country’s second-largest property developer. While officially a private company, Evergrande and China’s other giant construction companies have always been heavily linked to the state and it was presumed the state would intervene to bail it out when it announced liquidity problems last year.

Chinese faith in construction companies and the property sector has been eroded and the result was a worse-than-expected 1.3% year-on-year drop in prices over the 12 months to August. That’s according to official figures with suspicions the real state of the market, until recently a seemingly unstoppable engine of growth, could be worse.

chart china

Source: The Guardian

Research by Citigroup published by the Guardian newspaper in September found that nearly a third of all property loans in China were by then classed as bad debts – 29.1%, up from 24.3% at the end of last year. That increase has been driven by property developers rather than homeowners.

Despite recent commitments by Beijing to invest £26 billion in kickstarting the country’s housing market, things don’t look good. Around 2 million off-plan homes, in 2021 90% of new homes in China were sold off-plan, remain unfinished across China, according to a rough estimate by S&P. That figure will grow if sales continue to fall and developers continue to run out of money to complete projects.

S&P wrote:

“China’s property downturn has turned into a crisis of confidence that only the government can fix. If falling sales tip more developers into distressed territory, things will get worse.”

The issue stems from the decision taken by President Xi two years ago to clamp down on the “reckless” levels of debt being built up by property developers. But since the lending to these companies stopped, many haven’t had the liquidity to finish the properties they already had under construction. The cash raised from off-plan sales had already been re-invested in buying the next piece of land or starting construction on the next project.

President Xi and the Chinese Communist Party more broadly have not only cracked down on the property sector over the past couple of years. China’s authorities became concerned about the growing power and influence of the largest companies in the private sector more generally, and their hugely wealthy owners.

The tech sector, which many of the country’s biggest companies like Alibaba, Tencent and TikTok-owner ByteDance belong to, was another high profile target. Chinese internet companies contribute 20% of the aggregate net profits of China’s top 500 companies. However, a government crackdown which often seemed indiscriminate and without any obvious pattern or internal logic, sent out a message to companies and wealthy owners about who is ultimately in charge.

The crackdown has forced major companies, including Alibaba and Tencent to cut jobs over the past couple of years. Some of the other major repercussions were listed by Axiom China as:

  • Food delivery giant Meituan lost half its market value — tens of billions of dollars — last year after regulators required food delivery apps to cut their fees.
  • After riding hailing app Didi went ahead with its New York initial public offering (IPO) despite a warning from China’s cybersecurity watchdog, regulators issued fines, temporarily prohibited new user sign-ups, and embedded government officials directly within the company’s ranks. Didi also lost billions in market value.
  • Regulators also halted the planned IPO of Alibaba’s finance arm ANT Group, at the time projected to be the largest IPO in history.

Last month, after changing the country’s constitution to secure a third term, President Xi Jinping effectively secured ultimate power for life and filled the country’s highest decision-making body with loyalists. Fears of tighter government control over businesses resulted in multiple stock market drops in the aftermath of the Chinese Communist Party Congress in October which cemented President Xi’s power.

The third major domestic policy to hit Chinese stock market valuations has been the country’s Zero Covid policy. Outbreaks of the Covid-19 virus in factories or elsewhere in the country have resulted in strict lockdowns that have seen workers locked into factories for weeks and neighbourhoods or whole cities cut off from the outside world.

That has hit the country’s GDP with a recent Reuters poll forecasting growth of 3.2% for 2022, well below the target of 5.5% and meaning the year will show one of the worst economic performances in almost 50 years.

Analysts are split on whether the Zero Covid policy will continue or not. Some have expressed the opinion there are signs there may be a pivot. However, Julian Evans-Pritchard, senior China economist at Capital Economics, predicted in late October:

“There is no prospect of China lifting its zero-COVID policy in the near future, and we don’t expect any meaningful relaxation before 2024. Recurring virus disruptions will therefore continue to weigh on in-person activity and further large-scale lockdowns can’t be ruled out.”

How big are the risks?

That investing in China necessitates taking on some significant risks is clear. However, there are also strong counter-arguments that short of a very serious incident such as an invasion of Taiwan, exposure to the world’s second-largest economy, offers serious potential upside investors should think carefully about ignoring.

China seems to have little economic incentive to make a move that would separate its economy from the Western markets it still very much relies on. This means the general consensus is that while it will continue to flex its growing geopolitical and military muscle in its region and beyond, and there are likely to be standoffs, any outright conflict is unlikely. At least in the near to medium term.

The tight control the authorities exercise over the economy also means it can be expected to continue to intervene, even if it periodically sends strong messages to the private sector and will seek greater involvement. Every time the economy has started to slow, there has been intervention and that can be expected to continue. This year a raft of stimulus initiatives have been launched.

Hao Zhou, chief economist at Guotai Junan International says:

“On the policy front, the overall policy will remain supportive. In our view, further policy impetus is required to buoy economic recovery, but additional interest rate cuts are unlikely during a period of aggressive global central bank rate hikes.”

The property market has also shown some recent signs of stabilising and even if more cash than has been promised by authorities is thought to be required, it is unlikely any large-scale meltdown will be allowed to happen. Chinese households losing a level of trust in property could also have a positive impact on equities.

Bloomberg reported the brokerage and investment group CLSA as predicting Chinese households will move 127 trillion yuan, £14.8 trillion, out of property over the next nine years and into other investment classes like equities, funds and bonds. If that happens, even to some extent, it would be a big boost to stock and other financial markets.

There are also hopes the property crisis is coming to an end. On Monday November 14, shares of China’s biggest property developer Country Garden leapt as much as 52% in Hong Kong after Beijing unveiled a 16-point plan ahead of the weekend that significantly eases a crackdown on lending to the sector.

Measures include allowing banks to extend maturing loans to developers, supporting property sales by reducing the size of down payments and cutting mortgage rates, boosting other funding channels such as bond issues, and ensuring the delivery of pre-sold homes to buyers.

Harry Hu, chief China economist for Macquarie Group is quoted by CNN as saying

“in essence, policymakers told banks to try their best in supporting the property sector”.

There are also hopes the crackdown on the tech sector may have ended for the foreseeable future, even if Beijing is likely to demand greater influence in how they are run. China bulls are convinced market capitalisation losses over the past two years mean China’s tech company’s are now extremely cheap. Eastspring’s Maldonado comments:

“Valuations had gotten very cheap and earnings expectations had gotten very, very low.”

Anand Batepati, portfolio manager at GFM Focus Investing, also recently told CNBC’s Street Signs Asia show that Tencent and Alibaba are “extremely strong companies” and that “unless you think that the government or some external force is going to destroy 90% of their existing business, then I think it’s a no brainer”.

He continued:

“Unless somebody thinks that the government is going to come and expropriate these companies … I think over the next three to five years, China’s tech sector could see another huge level of growth.” 

Should you consider investing in China?

A long term investment in China is a bet that the huge country will not pursue a strong isolationist agenda over the next several years. That is certainly not impossible but it also looks relatively unlikely, for now. There are hopes that this week’s meeting between Presidents Biden and Xi at the G20 summit might signal a thawing of relations, based on an understanding in both countries that tensions ratcheting up is not in anyone’s interests.

There does look like a good chance China’s stock market may have started out on a sustainable recovery this month and if that continues it may well be among the best performers internationally over the next year or two. That might prove a very tempting prospect amid the doom and gloom elsewhere for investors with a healthy appetite for risk.

China is likely to split investment experts for years to come. The potential is clear. As are the risks.

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International

Fighting the Surveillance State Begins with the Individual

It’s a well-known fact at this point that in the United States and most of the so-called free countries that there is a robust surveillance state in…

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October 23, 2023

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It’s a well-known fact at this point that in the United States and most of the so-called free countries that there is a robust surveillance state in place, collecting data on the entire populace. This has been proven beyond a shadow of a doubt by people like Edward Snowden, a National Security Agency (NSA) whistleblower who exposed that the NSA was conducting mass surveillance on US citizens and the world as a whole. The NSA used applications like those from Prism Systems to piggyback on corporations and the data collection their users had agreed to in the terms of service. Google would scan all emails sent to a Gmail address to use for personalized advertising. The government then went to these companies and demanded the data, and this is what makes the surveillance state so interesting. Neo-Marxists like Shoshana Zuboff have dubbed this “surveillance capitalism.” In China, the mass surveillance is conducted at a loss. Setting up closed-circuit television cameras and hiring government workers to be a mandatory editorial staff for blogs and social media can get quite expensive. But if you parasitically leech off a profitable business practice it means that the surveillance state will turn a profit, which is a great asset and an even greater weakness for the system. You see, when that is what your surveillance state is predicated on you’ve effectively given your subjects an opt-out button. They stop using services that spy on them. There is software and online services that are called “open source,” which refers to software whose code is publicly available and can be viewed by anyone so that you can see exactly what that software does. The opposite of this, and what you’re likely already familiar with, is proprietary software. Open-source software generally markets itself as privacy respecting and doesn’t participate in data collection. Services like that can really undo the tricky situation we’ve found ourselves in. It’s a simple fact of life that when the government is given a power—whether that be to regulate, surveil, tax, or plunder—it is nigh impossible to wrestle it away from the state outside somehow disposing of the state entirely. This is why the issue of undoing mass surveillance is of the utmost importance. If the government has the power to spy on its populace, it will. There are people, like the creators of The Social Dilemma, who think that the solution to these privacy invasions isn’t less government but more government, arguing that data collection should be taxed to dissuade the practice or that regulation needs to be put into place to actively prevent abuses. This is silly to anyone who understands the effect regulations have and how the internet really works. You see, data collection is necessary. You can’t have email without some elements of data collection because it’s simply how the protocol functions. The issue is how that data is stored and used. A tax on data collection itself will simply become another cost of doing business. A large company like Google can afford to pay a tax. But a company like Proton Mail, a smaller, more privacy-respecting business, likely couldn’t. Proton Mail’s business model is based on paid subscriptions. If there were additional taxes imposed on them, it’s possible that they would not be able to afford the cost and would be forced out of the market. To reiterate, if one really cares about the destruction of the surveillance state, the first step is to personally make changes to how you interact with online services and to whom you choose to give your data.

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International

Stock Market Today: Stocks turn higher as Treasury yields retreat; big tech earnings up next

A pullback in Treasury yields has stocks moving higher Monday heading into a busy earnings week and a key 2-year bond auction later on Tuesday.

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October 23, 2023

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Updated at 11:52 am EDT U.S. stocks turned higher Monday, heading into the busiest earnings week of the year on Wall Street, amid a pullback in Treasury bond yields that followed the first breach of 5% for 10-year notes since 2007. Investors, however, continue to track developments in Israel's war with Hamas, which launched its deadly attack from Gaza three weeks ago, as leaders around the region, and the wider world, work to contain the fighting and broker at least a form of cease-fire. Humanitarian aid is also making its way into Gaza, through the territory's border with Egypt, as officials continue to work for the release of more than 200 Israelis taken hostage by Hamas during the October 7 attack. Those diplomatic efforts eased some of the market's concern in overnight trading, but the lingering risk that regional adversaries such as Iran, or even Saudi Arabia, could be drawn into the conflict continues to blunt risk appetite. Still, the U.S. dollar index, which tracks the greenback against a basket of six global currencies and acts as the safe-haven benchmark in times of market turmoil, fell 0.37% in early New York trading 105.773, suggesting some modest moves into riskier assets. The Japanese yen, however, eased past the 150 mark in overnight dealing, a level that has some traders awaiting intervention from the Bank of Japan and which may have triggered small amounts of dollar sales and yen purchases. In the bond market, benchmark 10-year note yields breached the 5% mark in overnight trading, after briefly surpassing that level late last week for the first time since 2007, but were last seen trading at 4.867% ahead of $141 billion in 2-year, 5-year and 7-year note auctions later this week. Global oil prices were also lower, following two consecutive weekly gains that has take Brent crude, the global pricing benchmark, firmly past $90 a barrel amid supply disruption concerns tied to the middle east conflict. Brent contracts for December delivery were last seen $1.06 lower on the session at $91.07 per barrel while WTI futures contract for the same month fell $1.36 to $86.72 per barrel. Market volatility gauges were also active, with the CBOE Group's VIX index hitting a fresh seven-month high of $23.08 before easing to $20.18 later in the session. That level suggests traders are expecting ranges on the S&P 500 of around 1.26%, or 53 points, over the next month. A busy earnings week also indicates the likelihood of elevated trading volatility, with 158 S&P 500 companies reporting third quarter earnings over the next five days, including mega cap tech names such as Google parent Alphabet  (GOOGL) - Get Free Report, Microsoft  (MSFT) - Get Free Report, retail and cloud computing giant Amazon  (AMZN) - Get Free Report and Facebook owner Meta Platforms  (META) - Get Free Report. "It’s shaping up to be a big week for the market and it comes as the S&P 500 is testing a key level—the four-month low it set earlier this month," said Chris Larkin, managing director for trading and investing at E*TRADE from Morgan Stanley. "How the market responds to that test may hinge on sentiment, which often plays a larger-than-average role around this time of year," he added. "And right now, concerns about rising interest rates and geopolitical turmoil have the potential to exacerbate the market’s swings." Heading into the middle of the trading day on Wall Street, the S&P 500, which is down 8% from its early July peak, the highest of the year, was up 10 points, or 0.25%. The Dow Jones Industrial Average, which slumped into negative territory for the year last week, was marked 10 points lower while the Nasdaq, which fell 4.31% last week, was up 66 points, or 0.51%. In overseas markets, Europe's Stoxx 600 was marked 0.11% lower by the close of Frankfurt trading, with markets largely tracking U.S. stocks as well as the broader conflict in Israel. In Asia, a  slump in China stocks took the benchmark CSI 300 to a fresh 2019 low and pulled the region-wide MSCI ex-Japan 0.72% lower into the close of trading.
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Government

Forget Ron DeSantis: Walt Disney has a much bigger problem

The company’s political woes are a sideshow to the one key issue Bob Iger has to solve.

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October 23, 2023

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Walt Disney has a massive, but solvable, problem.

The company's current skirmishes with Florida Gov. DeSantis get a lot of headlines, but they're not having a major impact on the company's bottom line.

Related: What the Bud Light boycott means for Disney, Target, and Starbucks

DeSantis has made Walt Disney (DIS) - Get Free Report a target in what he calls his war on woke, an effort to win right-wing support as he tries to secure the Republican Party nomination for president. 

That effort has generated plenty of press and multiple lawsuits tied to the governor's takeover of the former Reedy Creek Improvement District, Disney's legislated self-governance operation. But it has not hurt revenue at the company's massive Florida theme-park complex.  

Disney Chief Executive Bob Iger addressed the matter during the company's third-quarter-earnings call, without directly mentioning DeSantis.

"Walt Disney World is still performing well above precovid levels: 21% higher in revenue and 29% higher in operating income compared to fiscal 2019," he said. 

And "following a number of recent changes we've implemented, we continue to see positive guest-experience ratings in our theme parks, including Walt Disney World, and positive indicators for guests looking to book future visits."

The theme parks are not Disney's problem. The death of the movie business is, however, a hurdle that Iger has yet to show that the company has a plan to clear.

Boba Fett starred in a show on Disney+.

Image source: Walt Disney

Disney needs a plan to monetize content 

In 2019 Walt Disney drew in more $11 billion in global box office, or $13 billion when you add in the former Fox properties it also owns. In that year seven Mouse House films crossed the billion-dollar threshold in theaters, according to data from Box Office Mojo.

This year, the company will struggle to reach half that and it has no billion-dollar films, with "Guardians of the Galaxy Vol. 3" closing its theatrical run at $845 million globally. 

(That's actually good for third place this year, as only "Barbie" and "The Super Mario Bros. Movie" have broken the billion-dollar mark and they may be the only two films to do that this year.)

In the precovid world Disney could release two Pixar movies, three Marvel films, a live-action remake of an animated classic, and maybe one other film that each would be nearly guaranteed to earn $1 billion at the box office.

That's simply not how the movie business works anymore. While theaters may remain part of Disney's plan to monetize its content, the past isn't coming back. Theaters may remain a piece of the movie-release puzzle, but 2023 isn't an anomaly or a bad release schedule.

Consumers have big TVs at home and they're more than happy to watch most films on them.

Disney owns the IP but charges too little

People aren't less interested in Marvel and Star Wars; they're just getting their fix from Disney+ at an absurdly low price. 

Over the past couple of months through the next few weeks, I will have watched about seven hours of premium Star Wars content and five hours of top-tier Marvel content with "Ahsoka" and "Loki" respectively. 

Before the covid pandemic, I gladly would have paid theater prices for each movie in those respective universes. Now, I have consumed about six movies worth of premium content for less than the price of two movie tickets.

By making its premium content television shows available on a service that people can buy for $7.99 a month Disney has devalued its most valuable asset, its intellectual property. 

Consumers have shown that they will pay the $10 to $15 cost of a movie ticket to see what happens next in the Marvel Cinematic Universe or the Star Wars galaxy. But the company has offered top-tier content from those franchises at a lower price.

Iger needs to find a way to replace billions of dollars in lost box office, but charging less for the company's content makes no sense. 

Now, some fans likely won't pay triple the price for Disney+. But if it were to bundle a direct-to-consumer ESPN along with content that currently gets released to movie theaters, Disney might create a package that it can price in a way that reflects the value of its IP.

Consumers want Disney's content and they will likely pay more for it. Iger simply has to find a way to make that happen.

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