Is China a bargain right now?

0:06Pushkin. At the beginning of this year, China was supposed to be the big trade. It was reopening from a period of zero COVID lockdowns. It had all this pent up demand. It was supposed to explode onto the investing scene. Markets were supposed to go up and to the right. Fast forward 10 months, that really has not happened. China has disappointed both in economic terms and in market terms. The CSI 300 index is now below where it was in 2019. Not a good result at all. Today on the show, is the Chinese market warning us that we should expect more pain to come? or is this a chance to invest in the world's second largest economy at bargain bid prices?

0:46This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in the New York studio, joined from London by a recovering Katie Martin. Katie, are you OK? I'm fine. I'm fine. I had a small altercation with a van on my bike and the van won. and yeah, so I got bounced off a bumper, but I'm okay. Like it really could have been a lot worse, but it was still unpleasant. We are incredibly grateful that you were okay and that the van was not more victorious. That would have been bad for everyone involved. Defeat to vans. But we're not talking about that today.

1:24We're talking about China. And today we thought we'd borrow this construction from our colleagues Hudson Lockett and Chung Long who have written a very nice article about the disappointment in Chinese stocks. They break down the reasons for the disappointment into three categories, slow growth, problems in the property sector, and geopolitics. Just starting with growth, right? You know, China has long been this like double digit growing economy, has this, you know, incredibly powerful demographic boost, has had, you know, wild capital expansion across the country. There's been a lot of talk about, you know, bridges to nowhere, but those bridges do add to GDP, at least in the short term.

2:00And now, you know, Chinese growth ambitions have been revised down. The growth target for this year is 5%, which is just kind of a fraction of what it was only a few years ago. Yeah, exactly. You know, growth has clearly slowed down. And this has been a massive disappointment to investors, right? Because they went into the start of 2023 thinking this is going to be a great year for Chinese stocks, just like they had pretty strong convictions about a lot of things. And 2023 has gone wrong for investors in a huge number of ways. But China is one of them. So the expectation was China took ages to come out of its COVID restrictions.

2:33And once they were lifted, everyone thought, well, growth is just going to go to the moon, right? This is going to be a fantastic trade. Actually, what we've seen since late January, when we had this kind of rush higher in Chinese stocks on the idea that growth was going to rebound really fast, Chinese stocks looking at the CSI 300 are down 19 % from that peak. Even though this has been a pretty unpleasant year in lots of different markets, that's really pushing it. This is really grim. And if you dig into the details on Chinese growth, you can say that there are maybe three problems. One of them, property, we'll get to that in a second.

3:07But the others are the consumers feeling a bit beat up still from the zero COVID environment, right? We got to remember, less than a year ago, all of China was in a really tight lockdown environment. People were saving at rates that we haven't really seen before in the Chinese data because they felt scared about the world. People in some of the biggest Chinese cities were going without food and medicine. And so this inspired what appears to be kind of a great cautiousness on the behalf of Chinese households. That has waned a bit. People are saving a bit less on spending a bit more. But we're still at what looks like kind of elevated consumer caution.

3:45The other issue is industrial overcapacity, which is a problem that China has struggled with many times before. There's too much stuff being made at the factories. There is surplus. They have to cut prices to sell it because there's too much stuff. There's too much stuff. But also, you know, big companies around the world have learned the lesson from relying too heavily on China for their supply chains. When China shut down as part of COVID, just like everywhere else shut down, people thought, OK, so we are stuck. look, we don't have any alternative here. We're absolutely reliant on China to make our widgets, make our stuff.

4:19And so big Western companies have really spread that around a bunch of different countries and thought, well, just in case something goes wrong with geopolitics or with a pandemic or with, I don't know, some canal somewhere getting blocked by a massive ship, we need to just spread our risk around more. And there's a real danger that a lot of that manufacturing, that offshored manufacturing, doesn't actually go back to China after all. And, you know, I think the authorities in China have realized that growth is maybe a little softer than they'd like. And so they've engaged in, I wouldn't call it aggressive stimulus, but there's been some attempts to stimulate the economy.

4:54Yeah, there have been some efforts to kind of ungum the markets a little bit and, you know, push in some liquidity and try and make lending that little bit easier. There's also been some kind of soft stimulus in the sense that we've had some really substantial share buybacks from some kind of notable companies out there. And so there have been efforts to stimulate the economy. And so far, they haven't been noted by their success, I would say. But everybody knows that if China really wanted to fix this, and if it was absolutely fixated on fixing this problem, it's got a lot of room to stimulate still.

5:28So, you know, just because it hasn't done it yet, doesn't mean it won't do it pretty soon. My favorite part of the Chinese stimulus package so far is they've cut fees for parks and for other kind of recreational tourist events. I think that would be a great form of stimulus that we should bring to all countries. Just cut the park admission fee. So that's general economic growth in China. But we have to talk about the property sector, which it's almost hard to talk about growth without talking about property because it is the biggest single sector of the Chinese economy. It's like a quarter of the economy.

5:59It's absolutely just nuts. Yeah. I mean, some estimates say that if you count the indirect impacts of property, it's something like 40 % or half of the economy, but it's huge. And it's in what looks to be some kind of structural shift slash meltdown, depending on how generous you want to be about describing the situation. It's not great, right? No, it's definitely not great. We've seen a number of property developers struggling to keep pace with their dollar debt repayments, and that's not a great sign. It can be a little bit difficult to figure out exactly what's going on on the ground. But if that's an accurate representation of how much trouble the property sector is in, that's not a good sign.

6:37And that's definitely something that investors are worried about. And to just back up here, I mean, what happened was that China for a decade, two decades longer, perhaps, pursued a development model based on the financing of land, where you basically, you have land rights owned by the local government, and you use that to build a bunch of stuff. And And so all the land prices go up and everyone's happy and the economy grows. And that was like the fundamental way that China grew for a long time. And one of the consequences of that was there was a tremendous amount of debt out there in the Chinese economy.

7:11The authorities got very worried that this creates fragilities. And so a couple of years back, they instituted a policy called the three red lines where they tried to restrict the amount of leverage that could be used in development. And turns out an entire segment of the economy, if it's premised on borrowing, and if you kind of turn off the flow of borrowed money to that sector, things don't work anymore the way they used to. Yes, surprise, surprise. The economy definitely needs the property sector to be humming along a lot better than it is at the moment. And again, it is slightly tricky to tell whether we're at the beginning or the end of that process.

7:48You know, we have had some fairly harem scaram moments on some kind of big name Chinese property developers that the authorities have managed to kind of douse down and calm down. But it's just not in rude health as a sector. And I think given the anxiety around the property sector, people are talking about is a financial crisis possible in China? You know, a proper financial crisis. China has lots of mini financial crises, like peer to peer lending or whatever. But the basic mechanism here is you have all this debt at the local government level. That debt is majority owned by Chinese banks. Those Chinese banks are not particularly well capitalized.

8:25And if the local government debt starts to go bad, the banks have to take losses. And maybe you have a broader spillover through the Chinese banking system. Now, of course, the government would probably do something about it. They're not just going to watch their financial system melt down. So that's the big X factor, right? We have this pretty clear fragility in the Chinese financial system. and the government has levers to pull, will they pull the right combination of levers quickly enough and with enough kind of fortitude? That's the tricky part, right, is it kind of comes down to execution.

8:53Again, like Xi Jinping, you know, he may not be able to control absolutely everything that happens in China ever. But the government is very good at bending markets and the economy round to its will. So, you know, if you did get into a situation where it started to look really hairy, you've got to have a fair amount of confidence that they could try and turn it around. But yeah, we are definitely hearing voices that are not typical kind of China bears, raising the possibility that this could be uglier than we currently realise. If you look at the youth unemployment rates, they're not fantastic either.

9:26So yeah, we could be on the precipice of something potentially much worse. The counterpoint to that, I guess, is that a number of investors that I've spoken to recently have said, I just think this is overdone. China's had a horrible year. It's taken its punishment. I think there might be some opportunities out there. So, you know, make some market, I guess. Yeah. You know, it's the point of maximum fear where investors make a lot of money. Yeah, exactly. So that's growth and property. And that brings us lastly to geopolitics. I think this is, you know, for us as a market show, maybe a little harder to talk about.

10:00But I think the general point here is like, if you're a global investor interested in buying Chinese stocks, especially ones in the technology sector, which is like one of the most promising parts of the Chinese economy, You just don't know if the supply chains are going to work for those companies anymore. Like the U.S., it feels like every other week puts out some new restriction on high-tech chips and other stuff in the high-tech supply chain going to China. These things are kind of unpredictable, and it's not clear where the bottom is in terms of U.S.-China relations. Yeah, absolutely. And that's one of the reasons, you know, we've spoken a lot in recent shows about how global investors are warming to Japan.

10:34It's exactly that. They're thinking, you know, I can get the kind of Asia econ exposure without taking on the geopolitical risk. And so, yeah, we're seeing like, you know, offshore investors, you know, if you look at flows that go through what we call Stock Connect, which is, you know, a way to transact in Chinese stocks. We're seeing like some pretty serious outflows,$23 billion in net outflows since the start of August. you know, net inflows overall for the year so far are down massively on where we were just very recently. So investors are definitely nervous about this. It's absolutely true.

11:09And I think unquantifiable risks tend to be a little scarier sometimes, because you just don't know where it's going to go. It's a tail risk, as they say. So that's growth property and geopolitics. And Katie, this brings us to the kind of ultimate question. Are we looking at China trading at cheap valuations or are we looking at a value trap? I have been seeing more and more people talk about the so-called new three of the Chinese economy, the battery sector, electric vehicles, and renewable energy like solar panels. There's a lot of people that are trying to carve out a little niche in the Chinese economy that can be investable while the kind of rest of it is dragged down by these growth problems and geopolitical problems.

11:52I think people are trying to kind of reformulate the China investing thesis. But I mean, to me, it feels way too risky when you have Japan coming out of what looks like a 30-year bust. You can invest in Taiwan or Korea or, you know, invest in the UK. Why not? If you really like the risk, go for the UK. Yeah, you know, like I say, there are definitely some investors who think, okay, this is overdone. Just China has had too, too bad of a year. But the other thing that's on top of this is, you know, the last time that people were having serious conversations about, oh, is China uninvestable? It was down to a completely different set of risks, right, which was regulation.

12:29Suddenly the government decides that now we're going to pull this IPO over here, this an IPO, or it decides, right, we're going to have a huge crackdown on the education sector or on the consumer technology sector. And so even aside from all the other stuff we've spoken about, right, the growth, the property sector, the geopolitics, you have this regulatory risk. that is just present in Chinese markets that makes Western investors really nervous. So, yes, there might be some kind of, I like that you said niche, we call it a niche over here. European. Excuse my French. There might be some niche areas where you can try and make some money, but everybody knows that it just takes a little twist of the dial from the government, and that can go wrong really quickly, and you can lose a gigantic amount of money.

13:14So, all in all, is China uninvestable? Well, it's certainly not had a fantastic year. People are nervous about it. It could definitely get a lot worse from here. But, you know, 19 % down from the peak in late January, it's got to occur to you that a lot of that is priced in. I got to say, I kind of hate the word uninvestable. It's one of these meaningless investing world terms that you just say because you're really mad about the way that the stocks are done. I'm mad about everything. This bike lane is unrideable. Don't get me started. All right, Katie, we'll be back in a moment with Long Short.

13:57Welcome back. This is Long Short, that part of the show where we go long a thing we love, short a thing we hate. Katie, I have a very convoluted long today. I am long the two bills who were short long treasuries but are no longer short long treasuries. I, for one, have no idea what you're talking about. I think you do. This is Bill Ackman and Bill Gross, both famous investors, Bill Ackman of Pershing Square, Bill Gross, the bond king, formerly of PIMCO. Both of these men thought the 10-year treasury sell-off would continue, that bonds would continue to get cheaper. But they have both recently kind of reversed course and said, well, maybe the sell-off's about done or like we're at least comfortable where it is.

14:42Maybe this is a place to get But Treasury's cheap. Yeah. So the Treasury's market has been in, you know, the beatings will continue until morale improved mode recently. Bombs have just been getting killed. And effectively, Bill and Bill have said, OK, enough. Like these things are cheap enough at this point. This is run far enough. We're having a little nibble at this market now. We think maybe it's time to go long. And that has been cited at least as one of the reasons why the market has picked up very slightly in the short term. recently. Now, Bill Ackman is not exactly a big famous bond investor, but Bill Gross is.

15:18So, you know, on the margins, this seems to have been enough to at least, you know, pause the beating, shall we say. That's right. That's right. Yeah. I'm long their ability to ride this news cycle. I think that they've been getting some excellent press out of it. I've never seen Bill Ackman's bond trading covered so intensely as I have in recent weeks. Yeah, they are pros at this stuff. Yeah, that's for sure. Katie, are you short something and hopefully it is less convoluted. I am short getting knocked off my bike by motorists, which is quite simple to understand. What I'm kind of wondering at this point is maybe the listeners can share their thoughts.

15:57I have been cycling for a long time. I've had a number of scrapes, none of them my fault. Am I like gonna run out of luck here? Like statistically, should I keep going or am I kind of just hurling myself towards the big one where it's an accident that I don't easily come back from. I don't know. The statistician in me wants to say, well, these are independent events. So the fact that they've happened doesn't mean they're more likely to happen in the future. The less statistically oriented part of me says, Katie, losing you would be too high risk. Let's just, let's just, I'm sending you some elbow pads, some knee pads, like whatever you need.

16:31Let's keep you safe. I already like ride along, like when it's dark, like an actual Christmas tree. I light up my helmet. I light up the front and back of my bike. I wear one of those jackets that looks like the moon. It's just like totally reflective. Like it's not that I'm not visible. I take all of these precautions and I still get knocked off my bike. If you live in London and you see a very shiny markets columnist biking around the city, do say hello. Do say hello, but please don't knock me off my bike. But please don't hit her. All right, Katie, thanks for being here. We'll have be back next week.

17:04And listeners, we'll be back in your feed on Thursday with another episode of Unhedged. Catch you then.

17:12Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Jacob Weisberg, and Jess Trulia. FT Premium subscribers can get the unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.