September 17, 2021
In mid-August, the world’s largest money manager, BlackRock, recommended that investors increase their exposures to China – that is, the percentage of their portfolios – by two to three times, as reported by the Financial Times.
In the world of asset management, tweaking a portfolio by a few basis points (that is, hundredths of a percentage point) is a this-is-the-hill-I’m-dying-on position. In that context, BlackRock’s suggestion is as grounded as the manager of the New York Yankees baseball team bringing in the Kool-Aid Man to play shortstop and the ghost of Abraham Lincoln to pitch.
It’s saying: Buy China up to your gills… fill your boots… and just buy, buy, buy. During normal times, that kind of hyper-ultra-bullishness on China would be head-turning.
But in light of the recent measures taken by the government of Chinese President Xi Jinping (most of which had been announced before BlackRock planted its flag in August), it’s downright outlandish… idiotic… and terrifying.
And, most importantly, not all are 401(k)- or brokerage-balance friendly… no matter what your contrarian Spidey-Sense might be telling you.
Welcome to the Investor Smackdown, Chinese-Style
It’s a long list:
Tech crackdown: A nearly year-long, wide-ranging crackdown on dozens of publicly traded Chinese tech companies by antitrust regulators, as well as over concern about the handling of critical information by publicly traded companies (see more here.) Shareholder value destruction: Upward of $1 trillion and counting.
Education-technology company wipeout: Tutoring companies are no longer allowed to earn a profit… list their shares abroad… or have foreign investors. Around $90 billion in shareholder value in the largest Chinese ed-tech companies has been vaporized.
Wide-ranging cybersecurity focus: All Chinese companies in the (take a deep breath) energy, telecoms, transport, finance, and defense sectors are put under the cybersecurity microscope to protect “critical information infrastructure.” The risk to shareholders of this kind of scrutiny is clear and present.
Gambling clobbered: Earlier this week, an index of the shares of casino companies operating in Macau – the world’s largest casino center, around seven times larger than Las Vegas – dropped by the most ever in one day to all-time lows (erasing $20 billion in shareholder value), amidst hints that the sector will be subject to increased regulatory oversight.
Video games capped: In late August, The Chinese government limited children in China to three hours of online gaming per week, and a state newspaper labeled video games “spiritual opium.” Shares of former market darling Tencent are down more than 40%. (Tencent’s all-time high market capitalization in February was nearly $1 trillion.)
Real estate under pressure: Regulators are warning Evergrande – one of China’s largest real estate groups (share price down 90% over the past year) – to address its debt issues… Meanwhile, earlier this week, U.S. private equity heavyweight Blackstone ended its effort to acquire property developer Soho China for $3.3 billion when regulators didn’t approve the deal within a specified timeframe.
We’ll take a piece of that: The Chinese government took a small stake (and a seat on the board) in the company that owns TikTok, as well as in Weibo – a Chinese platform similar to Twitter. Part of the government’s interest is in the algorithms of technology companies, which is arguably the most important asset of TikTok (approximate valuation range: $200 billion to 400 billion).
A Communist Nanny State
Then there are the nanny-state measures, which reflect a sharp shift in underlying attitude…
Don’t drink alcohol: Central Commission for Discipline Inspection – the Chinese Communist Party’s (“CCP”) anti-corruption arm – warned that pressure to drink alcohol should be replaced by “correct values,” as part of an effort to crack down on after-work drinking.
Beware dangerous karaoke song lyrics: China’s culture ministry said it would ban karaoke songs with lyrics that might “inspire listeners into drug taking, gambling, and religion,” according to the Financial Times (as well as content that might be seen to “endanger Chinese sovereignty”).
Entertainers in the crosshairs: Chinese regulators aim to “resolve the problem of chaos” in online celebrity culture by banning popularity rankings and regulating companies in the sector. Several high-profile entertainers have recently been accused of rape, tax evasion, and other crimes.
All of these measures are packaged under an evolving policy rubric called the “New Development Concept” – which sounds boring but (especially if your IRA is at risk) most definitely isn’t.
As part of it, Xi aims to reduce China’s reliance on exports, and to make domestic-consumer demand the most important driver of economic growth. A piece of this process is to expand the reach of industrial policy, in which the state – rather than private enterprise – takes a leading role in how companies invest and grow, particularly in the technology sector.
And last, and maybe most worryingly, is the New Development Concept of “common prosperity.” It’s about focusing on redistributing income and wealth from the rich to the middle class and poor – which is about the most unfriendly investor philosophy imaginable.
It sounds downright… communist. Wait, what’s the name of the political party that runs China?
Mr. Foreigner, China Doesn’t Need Your Stinking Money
But wait… Doesn’t China need the cash of outsiders – foreign investors – to support its economy?
Actually… no, not at all. In fact, it’s just the opposite.
China’s nosebleed national savings rate of around 45% (which is the share of disposable income that’s saved rather than spent on consumption) means that the country’s economy has plenty of domestic capital to draw from to invest and fuel economic growth.
Comparatively consumerist Americans, with a savings rate of 19% (also from 2019, and according to the World Bank), puts the American economy in a very different position – and in constant, dire need of foreign capital (including Chinese) to buy its government bonds.
What’s more, too much foreign capital inflows – for example, if foreigners buy more Chinese stocks – creates problems that the country’s government just doesn’t need. Over time, that increase in foreign money could drive up the value of the renminbi, China’s currency… and in so doing, make Chinese exports less competitive (which would also hurt economic growth).
Of course, the Chinese central bank could buy dollars – as they flow into Chinese assets – to try to limit the appreciation of the renminbi. But eventually – to fast forward through a few chapters of your old Macroeconomics 101 textbook at once – this would trigger a boom in domestic credit and an asset bubble… two market challenges that China is already facing, and which the government doesn’t want to get worse.
Alternately, to try to balance investment inflows, China could encourage its citizens to invest abroad. But that opens a Pandora’s box of other issues, most notably one of control: As soon as the money goes elsewhere, so does the Chinese government’s ability to track it.
And what Xi Jinping has in common with politicians everywhere – particularly those of an authoritarian bent (think: Russia and Turkey, for starters) – is an all-encompassing, spread-eagle, full-bodied, opioid-laced-with-crack lust for control… and its kissing cousin, power.
And the shorthand here is this: Too much foreign capital equals less control and power. In other words, your shareholding in that China ETF, or that hot China ADR, would be sacrificed early and often.
BlackRock Wouldn’t Be Talking Its Book… Would It?
Back to BlackRock, which in its 2021 mid-year market review warned (seemingly without irony) that “China is pushing through reforms that could weigh on the quantity of growth in the near term but potentially improve the quality in the long run.”
And BlackRock’s more recently upbeat perspective on China seems to deny… well, everything that’s going on in China, which suggests the question, why?
As it happens, it was just in June that BlackRock became the first global-asset manager to win regulatory approval to launch a wholly owned (that is, with no local partner) domestic Chinese mutual fund business. While that’s not exactly an invitation to mint money, in the world of asset management, it comes close.
And – yet another strange coincidence! – the month before, BlackRock got the nod to launch a wealth-management business, which it will majority own, in part with a big local partner. It was also a big coup.
Surely those sorts of business considerations – like, say, staying on the good side of the Chinese government by promoting China as an investment destination, despite overwhelming evidence to the contrary – wouldn’t cloud the perspective of an asset manager’s insight and research, and advice to customers, would it?
If you’re considering trading up for an iPhone 13, this shocking tale could change your mind. Get the full story now.
Would You Marry This Market?
BlackRock is talking its book… that is, it’s aiming to support its own business interests in China, whatever the cost (the cost, that is, to anyone who listens to its advice about China).
“Pouring billions of dollars into China now is a tragic mistake. It is likely to lose money for BlackRock’s clients,” wrote investment guru and philanthropist George Soros in the Wall Street Journal, in an opinion piece titled “BlackRock’s China Blunder.”
That’s because right now China is uninvestable. It’s the ultimate investment insult, or declaration of futility or worthlessness. It’s like “unmarriageable” in Victorian England, or a car with no engine, or a thousand-piece puzzle that’s missing a single piece… that is, useless and pointless, and why are we even talking about it?
Earlier this month, a Financial Times columnist, in addressing the investability – or lack thereof – asked…
Does the CCP [Chinese Communist Party] care about what happens if foreign investors take flight? Do outcomes for foreign investors figure in the party’s political calculus?
The conclusion… No, not at all. And, the piece concluded, “China may not be uninvestable.”
That’s like saying someone is marriageable when there’s no other living soul left on Earth… or claiming to make that engineless car drivable by doing it Flintstones-style… or, here’s a sheet of paper, markers, and some scissors to make that missing puzzle piece.
And investors are voting with their feet. Chinese tech stocks are among the biggest “underweight” (that is, less than the benchmark index suggests) positions of actively managed portfolios.
According to Copley Fund Research, the global stock fund’s average exposure to China and Hong Kong – that is, the percentage of total assets that is invested in those markets – is the lowest it’s been since 2016. And the average “underweight” relative to the global investment benchmark index is the highest it’s ever been.
In other words… no one likes China.
(A more extreme version of “uninvestable”… In August 1998, the Russian government defaulted on $160 billion in domestic debt. Investors were so upset that – as the head of the Moscow office of an international brokerage told a reporter – “After this, Western investors would rather eat nuclear waste than buy Russian debt.” While Chinese shares aren’t in vogue, it’s not like snacking on used uranium… yet, at least.)
If It’s So Bad, Shouldn’t I Buy?
It’s the siren call of contrarian investing: If sentiment is so bad… doesn’t that mean it’s a good time to buy? After all (cue the Warren Buffett quotes, the Jim Rogers quotes, the “buy hated assets” quotes), that’s how the real money is made – right?
We celebrate investors who go against the grain and win big. There are times when emotions rule, and market logic goes out the window, creating enormous opportunities for steel-stomached investors.
But it’s easy to forget that most of the time, “they” are right… That is, the collective and conventional wisdom, experience, and insight of smart people, the mainstream, the financial-industrial complex, the annoying people who do the research and take the time – more often than not, those folks are correct.
Just now, they’re saying that investing in China is a lousy idea, and just because they are saying it doesn’t mean it’s wrong.
And just now, investing in China isn’t as contrarian as you might imagine, dire headlines notwithstanding…
The best way to gauge the out-of-favor-ness of a market is to look at valuations (like, say, the price-to-earnings ratio) of stocks and stock markets relative to their historical levels. After all, just because a share price falls by, say 50%, doesn’t mean it’s cheap – it only means (all else equal) that it’s cheap-er than it was 50% ago. But it might still be a whole lot more expensive than it was just a year or two ago.
And just now, Chinese shares – the CSI 300 Index (mainland China shares), the Hang Seng Index (Hong Kong), and China ADRs (listed abroad) – are trading at valuation levels at or above their 10-year averages. That’s partly because a lot of Chinese stocks had a big rally… and are still deflating from the resultant valuation premiums.
They have a long way to go before they’re cheap… and truly contrarian.
We Were Warned
It shouldn’t be a surprise that the Chinese government doesn’t care about the share price of Chinese shares, or how much you’re down on your Tencent position. And it’s no shock that the world’s biggest asset manager is offering up advice that you’d only offer your worst enemy…
What’s happening today in China is a structural shift… This time it is different – for contrarians, and for everyone else, too.
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September 17, 2021