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Capital Markets
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4 min read
Investing in China—once viewed as a no-brainer way to riches by some of our most popular and successful investment managers—has gotten quite treacherous this year. From the cancelation of Jack Ma’s ANT (China’s largest digital payment platform) IPO and its subsequent surrender to the regulatory arm of the People’s Bank of China, to the neutering of Didi, China’s version of Uber, to declaring the multi-billion-dollar school tutoring industry non-profit with the stroke of a pen. Needless to say, it’s been quite a few months! Essentially Beijing has changed the rules of the game right in the middle of the game.
In response, Cathie Wood’s ARK Investments dumped a very large percentage of its Chinese stock holdings. Other notable investors have declared Chinese stocks “un-investable”, and the SEC is ramping up new disclosure requirements for Chinese IPOs. It is hard to argue with any of these reactions. However, we are reminded of Warren Buffett’s axiom, “Be greedy when others are fearful”. There is plenty of fear so the question to be asked is, is it time to get greedy?
What we are seeing is the launch of perhaps the final phase in China’s decades long plan to achieve economic prosperity and become the world’s preeminent economic superpower. President Xi Jinping and the ruling People’s Communist Party have said thank you very much to Jack Ma and other corporate leaders of China’s gilded age for letting their entrepreneurship, ambition and greed to run wild. Now it is time for these titans to stop acting like American corporate titans. They will still be fantastically rich but no more books and speeches providing answers and advice to the nation, sometimes lecturing and even worse, contradicting the People’s Communist Party. Time to dial back the outrageous conspicuous consumption. There won’t be any Chinese Jeff Bezos launching himself into space. Now is the time for what Xi has labeled “Common Prosperity.”
For the last eight months China has been in the middle of a fascinating new phase of their multi-decade plan to transform their society into the world’s preeminent economic superpower. If we look back to the late 1970s when Deng Xiaoping took control of the ruling Chinese Communist Party and declared “Getting rich is glorious,” China has been on a mission. The Chinese started with measured steps to turn the forces of capitalism loose on society under the auspices of the Party, allowing for the excesses and societal problems naked capitalism can bring such as yawning economic inequality, terrible working conditions, pollution, and corporate corruption in order to achieve economic escape velocity. Despite the usual bumps in the road, the capitalism phase has achieved its purpose now seems to be getting adjusted to provide common prosperity. Who knows if they drew it up exactly this way in the 1980s, probably not but regardless, when we look down the road, the strategy looks pretty brilliant.
An authoritarian regime needs legitimacy to rule unfettered for decades into the future and the Communist Party’s legitimacy rests in the steady advancement of its population’s standard of living. Saying or doing the wrong thing can get you thrown in jail or worse, but the reality is, China has never had much in the way of civil liberties so that probably doesn’t figure into the Party’s calculus. Explosive economic growth since the 1980’s has propelled an unprecedented number of citizens out of poverty. However, the majority of China’s enormous population still lives in poverty. Additionally, in the race to achieve rapid economic growth (and make their new capitalists rich) the majority of the population still live with polluted air and water, a sometimes very suspect food supply and poorly built and maintained infrastructure. The Party knows that they can’t have 800 million or so citizens impoverished without hope forever. Therefore, the doctrine of “Common Prosperity” is a vital strategy of self-preservation by the Party.
Party literature often refers to the olive, when it describes how it wants society to look when the mission is complete. It wants the distribution of wealth to be thin at both ends (Poor and Rich) and very fat at the middle (Middle Class). Imagine a real middle class double the size of the entire population of the U.S. Currently however, the middle class in China is simply over-worked and the Party has been very clear that it views what is called the 9-9-6 lifestyle as unhealthy and an impediment to its “Olive Goal.”
The 9-9-6 lifestyle means start work at 9 a.m., end work at 9 p.m. and do it 6 days a week. The Party realizes that the 9-9-6 lifestyle allows nearly zero time for the pursuit of happiness (which entails buying things and supercharging the service economy) and threatens something vital to any growing economy, making babies. After decades of the one-child rule in China to control the population, China is now reversing course. It is almost as if the Party needed to limit population growth when 80% of the population lived in poverty. Now there’s less poverty and there is now an economy for the population to grow into.
When we look at the investment landscape in China, for the relative short term, we see what other investors see, a game where the rules are somewhat unknown. However, past the very short term we believe that we are seeing the new rules and the endgame. The Party’s actions will squeeze profit margins on blue chip companies like Alibaba and Baidu (who are down from their 2021 highs 41% and 55% respectively) but they are being squeezed to grow the middle class to perhaps 600 million consumers to buy what these companies are selling. The Chinese still want capital, especially as they grow and certainly do not want to close out all the investment capital the U.S. has to offer any more than the U.S. does not want the Chinese to stop reinvesting their huge pile of U.S. Dollars in 30-year Treasury bonds yielding less than 2%.
There’s plenty of fear. It may very well be time to get greedy.
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