One of my “theories” that I have been trying to communicate to foreign investors for years is that, in China, the economy and stock markets work differently from ours, and both share prices and company operations move with different dynamics. It is therefore futile, and sometimes harmful, to use the methods of the City or Wall Street to estimate the value of the shares: to simply rely on analysis of multiples such as the P / E ratio, which is a function of two variables – price and profit – both of which move with different dynamics from those we are used to, it only amplifies errors.
How to successfully invest in China? Pay attention to social and economic policies
For more than a decade, I have emphatically advised not to pay too much attention to company balance sheets, to Annual Reports. Instead, I invite you to focus on other sources of information: documents and announcements of social and economic policies that China publishes frequently, sources that I divide into two groups: Type A) Official documents or announcements such as the Five-Year Plan, China Manufacturing 2025 which are enclosed, say, in a single and full-bodied PDF that dictates and clarifies the purposes or objectives of these policies, and Type B) Concepts that are not contained in a single document or announcement, but whose existence is gradually promulgated and distributed to the public through verbal communiques by leaders during conferences or meetings or written interventions such as interviews or Op-Eds.
Type B concepts, during the early stages of their existence, are not immediately clear to the non-experts, to those who cannot read between the lines, but even experts have to work hard to interpret the true meaning, the scope and, importantly, what is the progress of the works, to better predict the impacts over time. Only later, these concepts are then formalized in official documents and take the form of Type A.
The Silk Road, a striking example
A striking example dear to the Chinese leadership is the Silk Road. The first time this sentence was pronounced by Xi Jinping was in 2013, during a speech at the University of Nazarbayev in Kazakhstan. This first announcement was then followed by other verbal communications during other meetings with foreign leaders, and only in March 2015, two years later, the NDRC, the National Commission for Reforms and Development, issued the first official document with the details of the initiative.
In the months between the first announcement and the publication of the first official document, uncertainty dominated the debate between economists and experts. It would be easy for me too, with hindsight, eight years later to say “Eh, but we had it all figured out already in Kazakhstan”. This is not the case and in all honesty, in the first period, I had not imagined the extent of this initiative which would have transformed the economies of three continents: Asia, Africa and, in part, Europe. On the other hand, for the sake of honesty, I must also reaffirm that, however, around the announcement of the NDRC in 2015, I understood the magnitude of it and since then I have dedicated most of my studies to the analysis of this great initiative. So, when I came to the Italian government in 2018, I pushed for Italy to join this initiative, already having the analytical tools in hand to be able to estimate the risks and benefits for our country. Of course, the less experienced commentators were also the most critical and, having not followed events since 2013, they could not possess the knowledge to be able to offer objective analysis.
I wanted to recall the history of the Silk Road, because it is relatively well-known in Italy and internationally, and therefore useful as an anecdotal example or frame of reference that can be used as a method to better decipher the announcements, official or informal of the Chinese leadership, to anticipate their impact on economics and ultimately making the appropriate investment decisions.
Four Key Concepts to bear in mind before investing
With this method of analysis well established, let’s move on to apply it to a practical example of these days, the new mantra that has been circulating for some time among economists and representatives of the Chinese government: “Common Prosperity”, announced by Xi Jinping recently, but not yet formalized in official documents. It is a bit like being back in Nazarbayev and whoever first understands its implications will gain an edge.
Despite the surprises and comments of many Western media, the idea of Common Prosperity is neither particularly new nor malign in an absolute sense, but it must be well understood to stay on the right side of the equation, seizing the opportunities and avoiding the risks. Let’s look at some of the highlights:
1) It does not mean that getting rich in China will be considered bad, but rather the revenues deriving from excessive monopolies will be limited, through break-ups of companies in various operating branches or by limiting the market shares of individual operators. This is already happening with us with the antitrust rules, procedures well known to Western investors who therefore should understand them well also in the Chinese context without being surprised by the continuous positions of the Chinese government against the internet and technology giants, some of which are, indeed, de-facto monopolies.
2) The second point concerns not monopoly rents per se, but how to distribute responsibility for the social-economic development of the country between the public and private sectors. The questions that the Chinese leadership has asked itself are, inter alia, the following: is it acceptable that internet companies can enter the banking sector, offering their customers interest rates on the their prepaid cards balance, prepaid cards whose original use was to offer an electronic wallet to facilitate the exchanges of goods between C2C or B2C on Taobao or other platforms, but certainly not be transformed into a mean to mobilize the deposits and alter the yield curve, which is, obviously, the responsibility of the Central Bank and not Jack Ma’s? I believe that by putting the question in these terms, we cannot be surprised by the recent restrictions on these companies. Indeed, the surprise would be why was this allowed for so long? Anyone who was long surprised by this excessive laxity and had sensed that this could not last, would have been able to anticipate the government’s moves and reallocate its investment portfolio accordingly.
3) The third logical pillar of the “Common Prosperity” strategy lies in the word Common. In the past, Deng Xiaoping’s theory admitted an unequal distribution of wealth between strata of society. Indeed, the invitation was, for those who could, to get rich (Getting rich is glorious, phrase attributed to Deng). It was as if Deng actually pushed for a concentration of wealth to be created that would have the double purpose: 1) to create a concentration of capital in excess of one’s needs, a necessary condition to stimulate investment and, 2) to create a class of rich people, whose wealth would be transferred to the less affluent strata of society, just like the theory of Trickle Down Economics (or in my free translation “When the tide is high, all boats float), teaches us. This approach has worked and in the forty years since the reforms: although income inequality has increased, all income brackets have seen their real living standards increase. This has not happened in the US where Stiglitz correctly complains about the increase in absolute, and not relative, poverty among millions of Americans. For forty years, therefore, the Communist Party of China accepted a more capitalist rather than socialist approach not because it had changed its doctrine, but because the primary need was to eliminate poverty among the 800 million peasants at the time and therefore chose, as Thatcher, to bring the average up rather than down, even at the expenses of relative equality. Now, that this need no longer exists and the problem of absolute poverty has been solved (ignoring those economists who find interest in arguing that we still haven’t reached the perfect zero), the focus is once again on harmonious development and ensuring that the market, which has had its merits, withdraw a little and leave more space to the intervention of the State, which will take on the task of redistributing income and wealth in a more equitable way. Observers will have noticed that the “Common Prosperity” narrative began after the 2020 announcements on the abolition of poverty. And it is not a coincidence: once the reason for deviating from socialism does not exist anymore, we can return to our basic philosophy. Those who have guessed this have prepared for the change of pace, altering their weights in investment portfolios. In China, when the government announces the success of one policy, one must be prepared that another is about to arrive
4) Finally, even when the empirical evidence and the Party’s moves are not yet clear, your guiding start must be sought in the theory, which is well stated both in the Constitution of the People’s Republic of China and in the Constitution of the Communist Party of China. “Socialism is the basis of the system of the People’s Republic of China. Any attempt to break this system by individuals or organizations is prohibited ”. “The actions of the Party are based on the principles of Marxism-Leninism, the Thought of Mao Zedong, the Theory of Deng Xiaoping, the Theory of Three Representations of Jiang Zemin, the Scientific Perspective of Development of Hu Jintao and Socialism with Chinese Characteristics for a New Era by Xi Jinping “. The list includes all the theoretical contributions of the leaders who have succeeded to the presidency, formal or otherwise, from 1949 to the present. But it should be noted that the list begins and ends with similar concepts: Marxism and Socialism, albeit with Chinese characteristics, as representing the two fundamental pillars. Anyone who wants to invest in China must understand that the Party’s goal is to create a socialist, non-capitalist society and that there is no trend towards convergence with our Western social-economic system, neither with regards the real economy, nor with regards to the stock markets, nor, even less, the opening of the capital account and consequent internationalization of the Yuan. Everything that is different from Marxism in China today is only temporary and must be considered as a short-term tactical deviation (in China the short period is 10/20 years), necessary to solve contingent problems or to respond to crises, but the ultimate goal, the Nash equilibrium, remains Socialism. Those analysts who are taken by surprise is not because the Party has changed philosophy, but simply because they (the analysts) have forgotten what’s written in the Constitution.
Where to invest in China?
So where to invest? How to participate in these dynamics? I’ll talk about it in the next contribution. But to start with, I recommend reading the documents that provide a macro idea, starting with China Manufacturing 2025 which highlights the 10 industrial sectors where China has decided to aim: 1) Microchips and IT 2) Robotics 3) Aerospace 4) Ocean Engineering 5) Components for Railways 6) Electric Vehicles 7) Energy 8) Agricultural machinery 9) New materials 10) Biomedicine. In short, everything is written, but it must be well understood, because certain words, phrases and business plans can hide hidden meanings and, of course, attention to assessments and strategies for diversifying micro risks.
During a call with investors in the City of London, one of them asked me “So is the Equity Story of China so dead?“. My answer: “No. It was never what you thought. What died is your illusion“.