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China – The Bad Boys of the CCP

China has had a pretty tough time of it recently, in terms of market performance. We think that this might provide for some opportunities to buy at prices that are more fair value than recent.

In general, the market should be rebounding after Covid, and a Quarter 2 number of 7.9% growth in GDP figures is certainly positive even if it has to be taken into context of other economies which show similarly high rebounds, but importantly have been hit much harder than the Chinese economy. There is less to rebound FROM in China.

Banks have had their reserve requirement rate reduced and new domestic bond issuance is positive.

Not only that but banks have generally come through the real-time stress tests of the pandemic in good shape, where moratoriums on loan and mortgage repayments, and historically low interest rates have little negative impact.

However the noises from the Biden Administration in particular and the West in general, especially over Muslim persecution and HK clampdown, have led the regime to pivot their focus from allowing Chinese corporations, in ‘sensitive’ industries, to list on US or even HK bourses and look at listing closer to home in either Shenzen or Shanghai.

Indeed these companies have been the dynamic to push the growth figures ever higher – they have been at the forefront globally of what is termed ‘disruptive technology’.

Analysts at Martin Currie, a long established Edinburgh fund house, still like the growth story in the Technology sector, including cybersecurity, cloud computing and gaming.

For example, the Chinese e-commerce market is valued at a whopping $2.1 trn with growth forecast this year at 18.4%.

These are strong well-managed companies so why the panic?

Well, as you all know, China is ruled by the CCP – the centenarian Communist Party.

The party recently unveiled the latest in its 5 year plans, which vowed to “provide leadership in society, reduce inequality, protect the consumer and promote competition” – long standing ‘communist’ ideals.

Joking aside, many Sino-watchers understood the CCP had to be seen to re-asserting itself and took measures to ensure the message was clear.

Take the example of Didi. The ride-hailing company was ‘allowed’ to acquire its biggest two local competitors and through this has a 90% market share. This would not have been allowed in Europe or USA where anti-trust laws are more defined, so the CCP had to take action to prevent further abuses and to draw a line in the sand for further market dominance.But anti-trust issues are not a specific China problem, they exist everywhere.

As my friends at Dominion Capital Strategies put it:

“It can be said that the US innovates then tries to regulate. In Europe, they regulate heavily and innovate heavily or not at all. China innovates, waits for growth to manifest, then regulates quickly.”

Actually the sabre-rattling from the Biden Administration may help an increasingly nationalistic government at home control the trend for foreign listings, and in doing so strengthen the domestic capital markets.

There has been a clear divergence of performance between the domestic focused (and funded) Star 50 Index with those Chinese indices which are more accessible by foreign capital.

Fintech is such a new growth sector that there is rarely much regulation of this industry anywhere in the world, never mind in the emerging economies.

Another area of concern to the CCP and thus a focus of action was that of private education.

An incredible statistic supplied by Krane Shares was that 25% of urban family income was spent on AFTER school tutoring.

The choice facing the CCP was to somehow overhaul the state education system to ‘wean’ students away from private education and back to state teaching or to clamp down on the generally unregulated private tutoring sector.

There was, in reality, no real choice.

This spooked the markets, however, and not only in the education sector.

One example was NETEASE which plunged more than 13% in Hong Kong. This was because the company has a 66% stake in YouDao – an online accounting training software provider. Seemingly the fact YouDao is only 2% of total market value of NETEASE was ignored by market particpants.

There are numerous other examples of such fear gripping Chinese stocks, particularly in the e-commerce sector where many foreign investors were rushing for the exits.

We see value due to this, as with the S&P trading at 34x Price/earnings growth who can say that Baidu doesn’t seem interesting at around half that valuation, trading currently at 17.4x PEG?

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