Chinese shape shift: rectangles turn into circles?

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We published an article last week suggesting that the valuations of some high-quality growth companies are now pricing in investor concerns about the Chinese market. In other words, a lot of the bad stuff was “in price” or close enough. The piece generated a lot of reactions.

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Although the article was mainly about valuations, a number of you wanted to know more about other topics that led to the devaluation of the market. Our views on this are summarized below.

Business regulation

The South China Morning Post is a particularly interesting publication today. Published in Hong Kong, it is now owned by Alibaba, itself clearly under scrutiny but no doubt eager to be seen to say the right thing. So hardly free and objective paper. That said, when he reports that China’s antitrust chief, Gan Lin, has declared a quick victory in getting rid of the once-widespread practice of “choosing every second merchant” in the e-commerce industry, we are encouraged. Gan continues, “platform monopolistic behaviors and disorderly competition have diminished.” These are not the words of someone preparing for war, but rather setting the stage for rebuilding, confirming our view that the worst is behind us.

Another positive surprise came with the little-reported validation of Variable Interest Entities or “VIEs”. As a reminder, VIEs use contracts to simulate equity stakes in Chinese companies that are on the “negative list” for foreign ownership, which includes the majority of internet companies. The National Development and Reform Commission (NDRC) and the Ministry of Commerce first released a new version of the negative list, clarifying the position in favor of VIEs. Then, the CSRC specified the conditions for registration of VIEs abroad. All of this has, for the first time, given legitimacy to a structure that Alibaba, Tencent, Baidu, Meituan, JD and many others use to attract foreign investors.

The real estate sector

The only major concern we would have with China’s real estate sector is that public confidence in the value of bricks and mortar as an investment and store of value should evaporate. While local sentiment towards real estate has weakened, unsurprisingly it has not collapsed, with a rebound in home sales in December confirming that the “buy the dips” attitude still prevails. This has no doubt been helped by soothing words from the government and some relaxation of mortgage rules. Secondary prices in most major cities have actually increased slightly since around October.

It should be remembered, however, that real estate is no longer the only game in town for Chinese savings. One of the fastest growing sectors in China right now is wealth management, and this is partly fueled by the diversification of savings from real estate into stocks and mutual funds. , which current concerns are likely to accelerate. This is a trend that we believe is inevitable and sustainable, and holding East Money is spearheading it.

What about the debt black hole that shrouds Evergrande and others? From an equity market perspective, we would say that valuations now look (belatedly) rational. The most struggling developers’ equity has already been reduced to virtually zero, or rather the value of an option on some form of restructuring, and while there may be a few additional members to that sorry list, that’s largely in price for the most part. The fallout between the banks and other lenders is still ongoing, but, again, we wonder how big a surprise the stock market will now be.

economy

Finally, what about the economy at large, isn’t it slowing down, heavily indebted, aging rapidly…? Yes, yes, and yes… oh my, it looks more like Europe or Japan every day. But look a little deeper and things don’t look so bad. Exports are booming to begin with. The statistics are horribly skewed by Trump’s 2018 tariffs, or rather the efforts of Chinese exporters and US importers to avoid said tariffs, but there is no doubt that China’s share of global exports has reaccelerated. Covid helped meet our needs for PPE and additional electronics and gym equipment, but now it’s more about solar panels, batteries and electric vehicles. All these things we need to save the planet and, like it or not, they will all come from China. China already has vastly superior scale in these areas, and increasingly the best technology as well.

As notionally foreign companies with most of their production in China are trying to diversify their supply chains, there seems to be little slowdown in foreign investment in China, although it is mainly aimed at the domestic consumer. Add to that still positive equity and bond flows, albeit below 2020 numbers, and it’s no surprise that the renminbi is stronger than the mighty dollar. China does not have an inflation problem and has very few positive real interest rates. While many investors worry about the impact of rising global interest rates, it’s worth remembering that China is the only major country easing. We expect this to continue into 2022.


About the Author

Rob Brewis is one of three fund managers responsible for the Aubrey Global Emerging Market strategy. A Cambridge engineer, Rob began his career in 1988 at Thornton Management in London before moving to Hong Kong in 1989. There he managed the Asian Special Situations Fund for Crédit Lyonnais. Having been an early investor in a number of nascent Asian markets during the 1990s, he also managed several domestic funds investing in India, Pakistan, Indonesia and Thailand as those markets opened up to investment. foreigners and grew in size. Rob co-founded an emerging markets investment boutique, BDT in 2000 before joining Aubrey in 2014.

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