Are the China Bears Wrong? With Shehzad Qazi

0:00Are we in the most hated bull market in history? The S &P is up 17 % so far this year, and the NASDAQ 100 is up 43%. The highest number of people since 2008 are invested in the stock market, yet institutions haven't participated. And sentiment is not happy. What's going on? Well, at Real Vision, we'll be talking to the world's best investors and thinkers to answer that question in crash or boom, how to profit from what's coming. This is a really important topic, and this two-week special series starts on September the 11th with what I think is coming. I'll lay it all out for you, and then we'll hear from the others.

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0:58Are the China Bears wrong? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Shahzad Qazi, Managing Director at the China Beige Bug. Hi there. Great to have you with us. Great to be back. So, you know, we're seeing a little bit of angst today. U.S. equities having a down day, tech leading the way lower. Everyone's been chewing over, you know, this question of where is the economy headed? Where is inflation headed? We can't talk about the outlook for the global economy without having a good handle on what's happening in China. So let's start there. What is your data telling you about what's actually happening on the ground in China?

1:37Yeah, you know, just a couple of weeks ago, we churned out our brand new August data from the China Beige Book. And one of the core themes that the numbers reinforced is that while markets were extremely bullish at the beginning of the year, they have now very clearly turned too pessimistic and too bearish. The economy continues to hold much better than I think the consensus and mainstream view would have you believe between manufacturing, between consumers spending on things like travel and hospitality and dining out, even retail sales. There are very serious problems within the property sector and within the construction sector and so forth.

2:23But that said, China is not collapsing. So why is everyone so wrong? Where do you think the sort of misinterpretation is? You know, this is a long-running problem in the China-watching world where the pendulum swings and swings wildly from excessive optimism to extreme pessimism in a rather short duration. One of the core problems remains that I think market watchers just don't know what numbers to ultimately use and what numbers to rely on. And that has very serious implications. At the beginning of the year, that led to a lot of extreme positivism, as I said, about the economy. The idea that there was going to be a massive rebound and a wave of revenge spending in the economy was going to kind of skyrocket as soon as zero COVID was lifted.

3:14Those views were not grounded in numbers. That was just hope. And of course, when that never played out in any of the data, including, of course, China Beige Books, large-scale proprietary data on the Chinese economy, markets turned very, very negative and have gone just the opposite way. And again, it's a lack of data or an inability to truly understand the numbers as they're coming out, which continues to leave markets sort of guessing and, quite frankly, flying blind and making mistakes. Yeah, flying blind is right. And it is true. We had this massive disappointment over the reopening that never happened.

3:53They reopened that fizzled is the word that I think I heard used to describe. Not very technical, but I think we all understand what they were talking about. But and now there seems to be this sort of, you know, this trying to figure out the way forward. My colleague, Andrea, spoke with Michael Cerveille about it for the for the content special that we're doing that we're running, Crash or Boom, this week. And they talked about China. He said he was in that camp, but he has shifted a little bit given based on some of what he's seen coming out of the government. Let's listen to a clip from that and then we'll talk on the other side.

4:31So I've been cautious about China, which has been correct in a sense, but now everyone is getting very bearish on the other hand. So maybe I think it's time to scale back on that bearishness and hawkishness because of everyone else. And I have to note that what we've seen recently is the Bank of China adding a lot of liquidity through their open market operations. and when we've seen that in the past it has at least temporarily created a cushion for the equity market and equities tended to go up a little bit during those periods in China it has a very strong link between what the PBOC is doing with these open market operations and the stock market so that makes me a lot less negative than I was if you go back three four months on it and we'll see about that As I mentioned, that was for the latest installment from our special series, Crash or Boom, how to profit from what's coming to access that full conversation and the line of other terrific guests that we have coming on throughout the week and next week.

5:40Just scan the QR code or hit the link to sign up. Super exciting stuff. So it's an interesting, I think that part of the disappointment or frustration was that with the reopening and then when it fizzled, there was an expectation that they'd come with a bazooka of stimulus, right, and that they would support it. And it hasn't looked like that. It's been disappointing. Again, there's maybe expectations not matching reality. What are you seeing in terms of support from the government and what are you expecting, importantly? I'll go ahead and make a couple of very important points here. The first one is that, again, the China-watching world has really not been able to update their view about how Chinese policymakers are increasingly thinking about managing their economy and what the economic model needs to look like moving forward.

6:32which means that everybody is trained on the past post-global financial crisis model, expecting that when there's an economic downturn, policymakers are going to step in and throw a lot of money at the problem through easing monetary policy, through fiscal stimulus, large-scale projects. Now, that economic model has gone out the window for at least the last couple of years. I think Chinese policymakers have been very clear about the fact that they're willing to live with lower rates of growth. As a matter of fact, they fully expect them because they're much more interested in transitioning their economy to something that's more sustainable, that's much more healthy, and where they can bring down the very severe risks related to the overbuild of debt in the economy and so forth.

7:16Which means that if you understand that, then you would not be expecting a big bazooka being fired at the economy. And that's exactly what we've been telling our clients all year long, that do not expect Beijing to step in with big, you know, old school projects and fiscal stimulus support. That said, what you should be expecting and what we have seen happen so far is much more targeted stimulus taking place on the fiscal side. You know, very small amounts compared to what you used to see in the past. And the other component, which has also gone unnoticed, which is what we call monetary policy easing in plain sight.

7:54All year long, the CBB interest rates data that we've collected from companies clearly show that the cost of credit has indeed been falling. So there has been support on the monetary policy side. The concern isn't necessarily that the government isn't doing enough, but whether companies are feeling confident enough to go out there and borrow and invest and hire. That's the long term, or I should say that's the challenge presently within the Chinese economy. And that's the framework through which I would urge investors to think about stimulus and policy support for the year. It's a fantastic point.

8:32And that is the liquidity, I think, that Michael was referring to in the clip that we listened to. if you're looking. It's amazing because it's coming through the monetary policy channel, not the fiscal policy channel, where in the developed world, it's exactly the opposite. A lot of people talking about that after a long period where it was all about central bankers and monetary policy. Now we're seeing these fiscal impulses that people have to try to figure out the lead lag on that and the impact. So it's a very different world for everyone to get used to on both sides of the coin. Yeah, that's absolutely right.

9:05And I think that's going to be the case in China moving forward. And the other point, if I may, to keep in mind is that markets are always concerned about what's going to happen in the next six months and this year. Policymakers have to think about the next year and the year following and how to cautiously use stimulus to continue helping the economy if need be as China transitions towards this completely different form of growth and expansion than anybody is used to, including the Chinese policymakers running the country. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

9:40We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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10:49Yeah, and you could argue that the Chinese play an even longer game than they're able to, than people who are facing re-election cycles elsewhere. So talk to us about the property bubble and what's going on there, because Country Garden was in the news. And I think there's just been this concern that, and it feeds into the negativity and bearish sentiment we see, that there is just the mother of all property bubbles that makes what happened here in the great financial crisis look like, and subprime in the U.S., look like peanuts, and that they are trying to deflate it, but there's a lot of skepticism.

11:31It's hard to deflate bubbles, right? We see that all the time. Are they making progress in resolving that? What's it doing to the workings of the economy? How is that playing out in your mind? These are several important questions that you've asked here. So, you know, first of all, this property sector is not going to look like moving forward. It doesn't look like today what it looked like two, three, or five years ago. And it's not going to look the same ever again, meaning that property will not be the sector seeing massive amounts of buildup and growth and really being the big contributor towards China's yearly GDP growth.

12:08That's point number one. Point number two is that, look, Beijing actually decided to deflate the bubble at a time and place of their own choosing rather than dealing with what could have been an even harder landing, a bigger crash, and landing the country's economy into an even bigger hotspot. Now, pricking bubbles and deflating bubbles is obviously painful, which means that the problems that we've seen in the Chinese property sector in the last couple of years, I think are going to be here to stay with us for several more years. I think markets need to get used to seeing negative China property stories for a while.

12:49The housing market remains in a pretty serious malaise. The construction sector certainly is struggling as a result thereof. The commercial side of the property market, which gets overlooked quite frequently, is also hurting. And I think what you get in China is sort of this, you know, perhaps two steps forward, one step back if you want to be more positive about it. But you'll see, you know, months and perhaps even stretches at a time of longer than that where sales will look better, where prices will look like they're rebounding. But it may very well be accompanied by a downturn, by another developer that is looking like it's in trouble.

13:27I think the story, the saga is not over anytime soon. OK, so what does this mean? And that was the other part of your question. Are we looking at this metastasizing into something bigger, like a Lehman crash in China and, you know, a financial contagion bringing down the entire economy? And that's we repeatedly have pushed back to our clients. And of course, publicly, that that is not the outcome. You don't get a Lehman moment in a place like China where the banks are government controlled, where the government exercises an incredible authority to step in and take over projects to bail out particular parts of the industry, even if they're not looking to bail out the executives.

14:08They're, quite frankly, looking to punish these executives. And so the Lehman analogy is actually a really poor one, and markets need to move on from that as they try to think about what to really expect in the property sector moving forward for the next several years. If there was a crisis brewing, would there be the transparency for anyone to be able to see it? Even you, you know, even if you were monitoring, you know, closely what's happening on the ground, there just seems to be, you know, the environment does not seem to be one that that information is shared at all in China. Is that is that you know how much of a how do you quantify that risk for investors when you can't see what you're investing in?

14:54Because people will go out the risk profile, right? They're willing to do that if they get paid for it. But if they can't see it and quantify it at all, how is it even investable? Yeah, I mean, I think a lot of that is what's causing the investor angst, because what they are not sure of doing is even if they were to bet that, look, you know, at the end of the day, The government will step in to potentially protect homebuyers. The government will step in to potentially protect the vendors who are caught in between this. And, of course, that any type of larger systemic contagion would be stimming, and you would have other banks stepping over and recycling the bad debt, as you've seen in China.

15:32But at what stage does it take place? How effective is the policy response? What is the bottom line for foreign holders of these, whether it's the credit, the debt, you know, and all the rest? And do they get paid back? How much of a haircut do they have to take eventually, et cetera, et cetera? All those are certainly big questions and very difficult to resolve the answer to because there's a lot of opacity around the policy component of it. I think we saw that play out in the Evergrande aftermath, certainly. And that's still going on, as a matter of fact. So it's true that that makes it very difficult for foreign investors to truly gauge just how bad will it get for them and their portfolios.

16:14Yeah. So we're seeing that. So yes, so lack of transparency and a question of what happens if you are a foreign investor. Also, what happens if you are an international company, a multinational company? Apple, of course, released its iPhone 15 today, you know, just a short time ago, California time. We've seen Apple shares really under pressure in the last week after China announcing that it's going to ban government workers and employees from using iPhones. Is this a sign of more to come? I think so. So, you know, every few months over the last couple of years, you've heard a lot of, you know, our colleagues on the investment banking teams and the sell side world announced that the tech crackdown is coming to an end and it's going to be good times again for technology in China.

17:04And one of the things that we've always said is that don't think of this as an episode that's coming to an end, but think of it as an episode that is continuously now evolving in a variety of ways, as Chinese regulations, as Chinese policymaking vis-a-vis the United States, et cetera, continues to change. And this is part of that cycle. I think we have, you know, as the geopolitical competition between the United States and China continues to heat up, as the national security lens continues to dominate how both countries think about their policy vis-a-vis technology companies and technology use, I think there's much more that lies ahead.

17:42And so companies need to become much sharper in their risk management and forecasting what risks are out there rather than continuously hoping for the best that perhaps the worst is over. Yeah. So there's, you know, as a result of that, there's been a diversification away from China as, you know, within people's supply chains. If you're if you're in one of those, especially if you're in one of those sensitive sectors, the news reports of that may be exaggerated based on what's happening on the ground or the speed in which it's happening. But the conversations publicly are out there. And there are plenty of other countries that are happily, you know, waving the come make it here.

18:21India springs to mind. We know Vietnam has been a beneficiary. Is that a problem for China? If there's a flight of foreign direct investment as well as trade and people using it as a manufacturing hub, how does that fit into the vision China has for the future? Or is that a problem for the Chinese economy? Yeah, the vision that the Communist Party has for China and the leadership in China has for their own country is certainly to become one of the most important players in the technological supply chain. They want to be developing some of the most high-end equipment as well as actual inputs and selling those to the world.

19:07And that's where they would like to see the country go. So, you know, certainly getting divorced and being, you know, this decoupling that is ultimately projected out in the technological space is one in which in the short run is certainly causing a lot of headaches and a lot of pressures within the party. That said, of course, you know, this conversation gets a little convoluted when you think about the fact that not all technology is created equal. And, you know, whereas you can take maybe lower value-add goods and move them out to another country in the neighborhood, maybe like in India, you really can't do that across the board if you're an Apple supplier or if you're Apple itself, right?

19:47I mean, as I like to say, iPhone cities can't be built and rebuilt overnight. So I think this is a longer-term play. If you look at another place like EV, for example, well, China's already one of the leaders in electric vehicles now, right? So it depends on what technology we're talking about. They're trying to catch up as rapidly as they can in the semiconductor space. So I think they're different. Depending on what technology we're talking about, the policy response is different. But certainly the pressures are there, and they're trying their hardest to prevent any type of larger decoupling from the Western world, whether it's Europe or, of course, important countries in Asia like Japan and Korea.

20:25Are we looking at a China that grows single digits now? What's your forecast for growth? The first thing I would say is investors should get very comfortable with the idea that sub-5 % growth is the future. We're absolutely in an era of moving towards single-digit growth. And if the economic transition begins to falter, and if policy fails at turning the ship around and going from this investment-heavy economy, investment-led economy to a consumption-led economy, We could be looking at a China that is approaching very low levels of growth, say something below 2%, around 1%, and maybe even no growth eventually.

21:08That's a big question. We just don't know where the economy is going to land, given this big experiment that is now being undertaken. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:27Wow. What does that mean for the rest of the world? Well, if you're a commodity supplier to China, naturally, that's bad news for you. If you are supplying heavy machinery to China, that's obviously bad news for you. And simultaneously, if consumption isn't growing, if you are in the business of selling luxury goods, and if you are in the business of selling other consumer items, all those things are naturally sharply against the projections we had. The world has run on the idea of China's economy not only growing rapidly, but growing rapidly to become the number one economy in the world. The idea that you've heard from major managing consultancies over the years is that it's not only the world's biggest consumer market, but it's also eventually going to be the strongest, most powerful.

22:10And I think a lot of companies are now having to rethink those assumptions, which perhaps may have been too early or too optimistic or a combination of both. A lot of people are very concerned about inflation and sticky inflation. But if that is what China's economy looks like, is that deflationary for the rest of the world? The long term outlook is more deflation out of China than China being the driver of any type of global reflation, which used to be a thesis for a while there. And that's certainly true. Is China about to spiral into this deflationary hole today? Is it there today? Absolutely not.

22:56Yes, there are very low levels of inflation. It's been great news for global central banks, especially the Fed. But what you're seeing in China today is closer to disinflation than outright, I think, deflation. And I continue to believe that that's going to be true for the rest of this year going into next year. But long run, yeah, of course, if growth levels continue to slow, deflationary China seems very, very likely and probably. Bo is asking, any comment on unemployment among the young Chinese? I've seen reports it's up to 50%. We know they recently said they're not going to be publishing that anymore.

23:29It's got to be a concern, or it's got to be considered an investment risk if they have a very large under or unemployed youth population. Yeah, on the technical side, I will say that the way the Chinese authorities put together their unemployment numbers is just really terrible, including the fact that they have this range where it's 16 to 19 and then 24 and then the rest of the country, which actually didn't work for them either because it just made it look like the youth unemployment problems was really, really bad considering those age droopings and how low they like to start. Putting that aside, China's youth unemployment problem, regardless of the numbers today, is linked deeply, deeply, deeply with the fact that they have been unable to have a growing and prosperous private sector.

24:14Because it's a private sector, it's the SMEs, it's the economies and the new industries that are going to be employing these young college graduates with very advanced degrees and advanced skills. And so till the time they fail to do that, they're going to have this problem. If they do indeed succeed, however, at providing credit and policy support to the private economy, the private businesses and SMEs, they could begin to turn around this youth unemployment problem. And that's the lens, again, the framework with which investors should try to gauge how good or bad the situation looks, not just this year and next year, but three to five years out and longer.

24:49So it's interesting. You're really identifying that as one of the key sort of leading statistics and indicators to try to track how they're doing in terms of pushing credit through the country. One of the ways they traditionally did that, if I'm not mistaken, is through the local governments, though. And this whole property bubble has really hurt that whole system, hasn't it? The property bubble and the local government vehicles to which this was financed was a really great way to grow the economic pie and to let, of course, local governments make a ton of money along the way, given the fact that they don't have taxation authorities and such.

25:29But it was still integral to and a result, I should say, of the old economic model in China, which was driven by the fact that build as many apartment buildings as you possibly can and shoot up the growth levels and we'll deal with the rest later. The item that I'm talking about is actually making sure that these old state companies, the industrial companies, the construction behemoths, a lot of zombie companies are not kept afloat by funneling the money to them, which ends up crowding out the small firms, the medium-sized firms that are working in the technology space or engineers, lawyers, accountants, media companies, all of which are always in the back of the line when it's time to access loans and such.