#5. China Asset Classes in One Chart

Topics: Liquidity Migrations, Demographics, Consumption, Construction, Foreign Investment, PPI, Tencent Earnings

Nov 17, 2021

This is China Charts. We are a pair of finance professionals with boots on the ground in China, each with 10 years of experience in the country. We love charts, mainly because of their ability to tell so much. In this newsletter we create and gather informative charts on the Middle Kingdom.

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I. Liquidity Migration Across Asset Classes

Capital controls. China has them. And they’re enforced. In retail banking, for example, one cannot exchange and wire out more than USD 50,000 per year. What’s more, one cannot really seek investment yields abroad. Transactions for wire recipients with keywords such as “asset/wealth/investment manager”, “securities”, or “broker” get automatically blocked. To get money out of the country for investment purposes, one has to have a personal account abroad (often Hong Kong) to be used in a two step wire from the mainland. Companies that facilitate investment abroad for mainland citizens are increasingly finding themselves in hot water. See recent state media criticism on China-based Tiger Brokers and Futu, both listed on US exchanges.

What this really means is that China is a walled garden (or “bird cage”) with liquidity sloshing around within its borders looking for yields. Traditionally, the granddaddy of investment vehicles in China was real estate. That’s why policy makers spend so much time attempting to stop liquidity leakage into speculative real estate every time there is a policy driven monetary expansion. Whenever China loosens loan quotas (e.g. for business loans), some of it inevitably just ends up in real estate, which isn’t really helpful in the aggregate. It’s a nightmare to deal with. But individual Chinese just really love their real estate. It’s the only asset class with seemingly perpetual upward drift, China’s equivalent of the S&P 500 in the US. This may be slowly coming to an end as we already detailed in our previous post on demographics and our post on the price trends across 70 core cities.

So what do you do if you can only invest within China borders and your options are limited? You chase. Why do you think China P2P had such a boom? Because it was an implicit promise that addressed a massive problem:

THE FUNDS PROVIDER. You’re an individual with increasingly stagnant wage growth (see 2nd chart here), some savings (but not nearly enough for a downpayment on runaway real estate), a near-zero interest bearing bank account, and few investment prospects? P2P can give you 10%+ yearly returns. And the government “should” provide a guarantee of principal anyways, right?
THE BORROWER. You’re an individual without access to credit, experiencing employment instability, and you’re increasingly feeling like you’re falling behind China’s boom of the last 30 years? The official China credit bureau only covers the top 15-20% of the population and you can’t even get a credit card. Big data, mobile-first, P2P can provide you credit. All from your phone, in minutes. At 30%+ APR you’ll still take it because the small print is deceptive. At least it’ll give you a breather.
THE TECH PLATFORM. You’re a high net worth individual, are a limited partner at a local VC, and are starved for yield? Pile into tech companies that in turn pile into P2P. Since it’s a race and competition’s brutal, the priority is loan volume issued. Charge-offs, fraud, and collection headaches are a problem you’ll deal with in the future. A sufficiently high interest (30-90% APR, no typo) should cover those inadequacies anyways, so you say.

It was the perfect storm. But as Morgan Housel writes in “The Psychology of Money”, “no one’s crazy”. Each agent in the P2P story was more or less acting rationally given their situation. But in the aggregate, what you end up with is boom-bust dynamics as so perfectly described by Edward Chancellor in his “Devil Take the Hindmost: A History of Financial Speculation”.

This dynamic tends to replay itself over and over in China. Stocks in China have high beta and are cyclical, none of that upward drift you see in the US. Stocks here largely live and die together. As they did in the booms of 2007 and 2015. They chop around in trading ranges the remainder of the time. Real estate cooled off in 2015-2016. While VC rounds saw a peak in 2016, which is unlikely to be matched again as we described in more detail in our previous post here. In 2020-2021, China commodities saw a boom (more on that later). And so now we finally get to our first chart of this week’s issue:

And here’s a breakdown of the individual commodities that we used to build the index:

Overall, one could argue that the trick to making it in China is timing. If you’re in the right time and the right place, you could catch a monster wave as liquidity migrates from asset to asset. It’s obviously harder than it sounds. But it’s a start.

II. Demographics

Expect another low number of births in 2021.

For instance, in Dezhou city in populous Shandong province, the number of newborns declined by 17.9% in the first nine months compared to the same period last year. His calculations -- based on statistics of hearing screening for newborns -- also show similar drops in central Henan province in the first half of the year.
Separately, a local newspaper in Anhui province estimated in September that births there would drop 17.8% this year, the fourth straight year of double-digit declines. In Taizhou city in eastern Jiangsu province, there were likely 43.4% fewer newborns in the first eight months of this year compared to last year, He calculated based on statistics from the local authorities. (Bloomberg)

In August this year, analysts at Jefferies noted births may drop to their lowest level since 1950.

III. Consumption

Helpful graphic from McKinsey defining seven groups of consumers.

Inflation is making retail sales look strong.

While in real terms it is still below pre-pandemic trend.

Source: Pictet Asset Management, via @PkZweifel

IV. Construction

Construction activity seems to be slowing, with implications for metals prices.

Floor space starts and sold have declined. Perhaps we are seeing a turning point in Real Estate investment flows?

V. Foreign Investment

China received a steady flow of foreign investment through the stock connect program in 2021, reaching a YTD seven year high in April and maintaining it.

Foreign investors RMB-denominated holdings steadily increasing.

VI. PPI

China’s PPI got a historical update recently, 4ish years worth of data tacked onto the beginning of the series. September and October no longer are the highest in the series history. It has been a long time since China recorded two double-digit PPI readings in consecutive months.

China, US and German PPIs are in double digit territory.

VII. Tencent Earnings (trial segment)

NOT INVESTMENT ADVICE. Do your own research.

Fintech & Business services is catching up with Online Games.

Fintech and Business Services is the fastest growing segment, while Online Games ins on another regulatory-induced slowdown.

Internet VAS (Online Games + Social networks) still leads on Gross Margin.

Tencent has been buying back their shares.

Tencent’s shares outstanding since 3rd Quarter 2015.

Here are some per share financials charted over time. (GP=Gross Profit, NP=Net Profit, OCF=Operating Cash Flow)

And here we compare the CAGR between total shares, Market Capitalization, Enterprise Value and the per share metrics from above.

James Mitchell on the earnings call, answering a question from Robin Zhu (Bernstein), said Tencent believes the regulatory environment is a new normal. They expect more regulations, but with less incremental impact over time as companies/industries adjust.

James’ comments fit with out belief: “regulatory” surprises will continue, even without new regulations announced, as the back-and-forth between companies, regulators and enforcers works through new definitions, timing, implementation and enforcement norms.

And we’ll finish with some technical analysis on the share price. The post-Archegos average share price was HK$613, about 30% above post-"Summer of Crackdowns" average of HK$473.

Please let us know if you liked this earnings trial segment.

China Charts