By Samir Mehta, senior fund manager of the JOHCM Asia ex Japan fund.
In April 2022, a former Singaporean MP extolled the virtues of the Chinese approach to the harsh COVID lockdown in Shanghai at a private group presentation. His main argument was to the effect that the authorities are not fools; even during the times of emperors, quarantine was the most effective way China had prevented transmission of disease.
A month later, the ‘white paper’ silent protest by the Shanghainese, an act of untold courage in a surveillance state, tipped the government to dismantle all barriers. In true bureaucratic speak, the adjustments were made to ‘promote epidemic prevention and control as well as economic and social development, and resume work and a return to normal life’, a city official deigned to pronounce at a May 29 press conference. They also emphasised that the term ‘lifting the lockdown’ was not to be used, as ‘static management’ is not ‘lockdown’ . Eric Arthur Blair (better known as George Orwell) would have smirked.
Markets are a fascinating study of human nature. The dramatic yen/$ carry trade unwind in August 2024 led to baffling volatility in stocks. In late September, comments first from the chair of the People’s Bank of China (PBOC) and then from President Xi Jinping, followed by a statement from the politburo uttered a few words which led to a frenzied surge in Chinese stocks. The unscheduled nature of the politburo comments on the economy conveyed not just the urgency of the intent but also the unconventional aspect of direct and specific utterances which we are unaccustomed to. In China, given their political system, once the leader has spoken, it’s all hands-on deck. My assumption is that the wheels of the government machine are already in motion, though details are sketchy.
Steeped in Marxist-Leninist ideology, President Xi, with an avowed abhorrence towards capitalism (unless state directed), portrays a sense of knowing the right path for every human condition. Until the last straw forces ‘U’ turns thus exposing a vacuous veneer.
President Xi has ideological differences with the liberal West on several fronts. Yet, on some of the monumental economic challenges, despite taking the moral high ground, his decisions have backfired spectacularly. When the residents of Shanghai protested his draconian lockdown, he had to give in. Unable to understand the hardships endured by the common man, the leadership pushes to extremes before recognising their folly.
The ‘three red lines’ policy announced in August 2020 was well intentioned. Most economists and policymakers knew that the bubbles in real estate (prices as well as overbuild) could be detrimental over the long run. The need to control leverage and dampen speculation initially worked well. Yet by 2023, it was evident that the economy, buffeted by sanctions imposed by the West, was starting to slow even more as a direct result of this clampdown. Either the leadership had never understood or perhaps actually chose to ignore how important real estate and construction were to the economy. The complex and intricate relationships between real estate and the general economy led to rising unemployment, deflation and severe financial distress for swathes of industries.
Fixated on a 5% annual GDP growth target, it mattered little how they hit that number. Redirecting credit to industries deemed nationally important was considered adequate. The continued strangling of the real estate sector intensified deflation. Local and provincial governments had lost their main source of revenues from land sales. Meanwhile entrepreneurs became risk averse, while consumers facing lower incomes and salary reductions accelerated loss of consumer confidence. Absurd decisions, like forcing banks not to buy long term bonds to prevent yields from falling further, could not hide the reality of a possible downward spiral of the economy.
Yet, what strikes me is that however extreme the differences in ideology across countries, we all worship at the altar of central banks and pray for quantitative easing and fiscal imprudence. No matter how financially irreligious you might be, there is no choice but to bend the knee to the monetary gods and the angels of fiscal spigots.
Ultimately, it was the Federal Reserve chair Jay Powell’s 50 bps cut in rates that gave the cover for steps announced by the PBOC in opening the liquidity tap in China. A weaker dollar made it easier for the PBOC to cut rates. Of all the measures announced, PBOC underwriting 100% of local government purchases of unsold apartments was momentous. The politburo’s utterances of actively pursuing fiscal policy to prevent a further fall in property prices and address unemployment was direct and unexpected. These are still promises but a ‘U’ turn has been made. This is of course evidenced by the ferocity of the rally in almost any China-related stock. Market participants had given up on China as un-investible because in our collective opinions, the Chinese Communist Party (CCP) would prefer to impose fiscal and financial discipline and not engage in any notable stimulus measures.
Many have argued that even Japan during its decades of deflation experimented with stimulus packages, which drove Japanese equities higher for short periods; I tend to agree. This rally can certainly continue given the apathy, short interest and bewilderment at the suddenness of change in policy. Yet, the crux for China remains a follow through of significant fiscal measures and most importantly a reversal of the ideological high ground of ‘common prosperity’ and not denouncing entrepreneurship. On that I think it’s better to assume no ‘U’ turns.
Some of these measures were unexpected but do not change our focus on the kind of companies we own in China. I still believe that prudence dictates identifying businesses in relatively benign competitive environments; management teams that recognise a structural decline in growth rates which makes them focus on costs, cash generation and high payouts. This change in heart by the authorities came as evidence of missing the 5% GDP growth rate for 2024 grew. They have not admitted the folly of strangling the productive sectors of the economy. Some ideological tigers, once ridden, are difficult to dismount.
Suffice to say, the persistent negativity prevalent around China has broken for the moment. As I argued in the last note on ‘Time to Take a Different Approach to Asia’, allocators of capital would do well to re-engage with this asset class. China’s change of heart is one of the big, unexpected changes that makes the Asian equities asset class worth re-engaging with. Almost every country in Asia has undergone significant transformations in multiple areas over the past decade. Most relevant for us, several well managed companies have survived the difficult years and calibrated business models to deal with increased complexities and hardships over the past years.
Asset prices do well over the long term when a confluence of three attributes come together. A cheap asset class, with improving earnings or cash flows, and ample liquidity. It is still early in the long-term outlook in my view.
Main image: nuno-alberto-MykFFC5zolE-unsplash
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The fund manager’s views are his own and do not constitute financial advice.
