Finding opportunity in China's turmoil
A series of recent measures enacted by the government in Beijing against Chinese businesses has created turmoil in China’s stock markets and anxiety among Western investors.
President Xi Jinping is reasserting the importance of the communist party in the lives of the Chinese citizenry.
Several high-profile IPOs have been thwarted as Beijing seeks to clamp down on entrepreneurs it considers to have amassed too much power.
Other measures focus on social equality or worker protections. For example, the “996” ethos––working 9 a.m. to 9 p.m., six days a week––that has fueled the rise of titans, such as Alibaba, has been declared illegal.
Beijing regards these moves as crucial to its far-reaching campaign to combat inequality, reduce social division, and encourage “common prosperity”.
Many in the West see them as undermining foreign investors’ interests. Shares in many Chinese companies have been pummeled.
Behind the headlines
According to Xiang ‘Sean’ Huang, Co-founder of First Beijing Investment Limited, an investment manager based in China, investors’ fears are overstated.
“The Chinese government isn’t going to roll back three decades of economic progress,” says Huang. “The long term is clearer than the short term, and our expectation is that these policies will make China and its economy healthier and more sustainable over the long run. We continue to see a rising middle class and more prosperity.”
More than 750 million people in China were living below the international poverty line in 1990, but by 2016––the latest year for which figures are available––this number had fallen to only 7.2 million, representing just 0.5% of the population. Since 1990, the average income in China has risen from $318 to $10,500, according to the World Bank, but the benefits are not evenly spread. Beijing’s view is that its market reforms will maintain the path to prosperity, while also improving socioeconomic equality.
Leveling the field
China is still an immature equity market. It is also a stock-picker’s market, where local expertise can exploit inefficiencies. Opportunities for the selective investor are particularly apparent today, as many in the West struggle to make sense of the government’s actions.
For example, the education industry plunged into uncertainty following reports that core parts of tutoring businesses may be conducted only on a not-for-profit basis. Huang says the regulations are aimed more narrowly at education providers for grades 1-9—companies that have been accused of putting younger children under severe stress and creating inequality. As China’s middle class has grown, the sector has attracted anxious parents seeking to improve their children’s chances of admission to the best universities.
The government is still said to be supportive of vocational education service providers. For investors, the ensuing market turmoil has created buying opportunities among companies whose underlying businesses remain unlikely to be affected by the recent announcements, but whose share prices have suffered collateral damage in the aftermath of the widely reported rule changes.
Fallout from moves against the Chinese technology giants may also present investment opportunities further down the market-cap spectrum.
“We think the very negative sentiment that prevails now is only temporary,” says Huang. “The long-term benefits could become clear in the 12 months and beyond.”
Parallels and presence
Some investment managers working in China have expressed confidence that Beijing is not performing a 180-degree turn in its approach to the entrepreneurship that has played such an important part in reshaping China’s economy. According to McKinsey & Company, the share of Chinese urban employment supported by private enterprises more than quadrupled––rising from 18% to 87%––between 1995 and 2018.
“In many ways,” says Huang, “China is still one of the best places in the world to be an entrepreneur. For the most part, the policies are pro-entrepreneurship. This is a great place to build a business, which is good news for well-informed investors.”
We appear to be witnessing now the risks of a Chinese business getting too big, similar to US and European regulatory scrutiny of the concentration of power among companies like Amazon, Apple, and Google.
“The Chinese system is fundamentally different from the Western system, and we have to accept that,” says Huang. “But in the end, although the regulations themselves might look different, the objectives are often similar. There are lots of subtleties at play.”