What to do with China?
Fri Oct 11 2024
Today we will talk about China.
What to do with China?
The economic situation China is undergoing has a strong parallel to the Japan bubble that burst in the early 90s. Unsold property and debt overhang dragged the Japanese economy for almost 20 years in a deflationary stagnation. There are many fears driving many investors away from China, one of which is “will China suffer the same fate as Japan?”. Investments in China is even more complicated given the political situation surrounding China. The economic malaise and deflationary challenges are real. Then why the market euphoria? In the longer-term, financial markets assets prices are driven economic fundamentals; In the short term, however, market positioning, sentiments and expectations can have an unusually large impact on prices.
The huge demand for long dated government bond during this summer which drove bond prices to bubble territory in China was a big wake-up call to the top policy makers. Deflation is not necessarily an evil if there is confidence underpinning economic growth. But if deflationary stagnation takes hold and confidence turned beyond a negative line, reviving this confident will be an almost impossible task. Even if this is achievable, the economic price required will be a big multiple of what would be required had it been a more benign situation. The huge unsold property and the debt within the property sector, negative wealth effect of a shrinking asset prices and stock market, and weak job market collectively mean the top policy makers are seeing the red line. Crossing this red line will even impact President Xi’s China Dream.
China past economic policies has relied on spending on infrastructure and property to drive growth. This time round, fiscal stimulus will be directed to support consumers, health, and family support, and increasing accessibilities for enterprise financings.
Is it time to buy into China equity? I belief we have seen the low of China equity in August 2024. Going forward, meaningful fiscal stimulus and other proactive government policies are required to continue to drive the economic growth. Like all investments, choosing the right sector and not chasing mindless rallies to insane level require discipline. As the second largest economy, a dominant manufacturing sector and a leading green tech giant, China has finally become investable after 3 years. We now know where the red line and the China-put is has come into play. This to me is the bigger news, not the mindless rally we witnessed last 14 days.
No market goes one way up or one way down and the next 6 months will witness many down draft as new buyers take over positions from investors cutting losses to exit the China market. Property will continue to be an overhang, and the global rates environment will limit China ability to maneuver and the size and timing of its fiscal support. There is no playbook to tell us how to choose the right investments, but the event in September does signal that China is back on our portfolio. I do not believe the valuations of many are priced right and I also do not think the property cycle has bottomed, but I think the healthy part of China should have a place in our portfolio.
Chariman