Friday, August 18, 2023

China's Lehman Moment

When the GFC broke out, we discussed that the repercussions will be felt worldwide across many years. In 2015, it hit Europe hard with the Grexit crisis and it was said that Asia and China needs to see its own Lehman moment. 

I think we just witnessed that - Country Garden's default and the collapse of Evergrande.

The buildup of woes at Evergrande was well known but no one thought that the biggest developer Country Garden could face issues. Now, all is laid bare and we know how deep the issues are. Property is a huge part of China's economy and when this piece of the chain breaks, it threatens the entire financial system. China's GDP growth may fall below 5% and there are concerns about China going into deflation, following Japan's experience in the 1990s.

Chinese authorities recently launched a stimulus bid by allowing major banks to reduce mortgage and deposit rates to boost sentiments. The stock market reacted positively for two days but the bullishness has since faltered as investors confidence remained low. The draconian measures to curb the Chinese private sector, notably private education and internet / gaming sectors remained fresh on people's minds and many market participants are still licking their ghastly wounds.

The representative stock would be Tencent (chart above). Once the darling of Chinese stock market, along with Alibaba, it is now trading not far from its pandemic low and the drawdown from 2021 to the bottom this year was a whopping 70%. The broader market is similarly trading near all time lows. See 2828 HK below.

China has been the world's growth engine for the past two decades and with this engine gone and with US equity valuation still high, it is unclear to me how markets can continue to rally. With risk free rate at 3-4%, the big question is why would anyone buy anything at 40-50x PER? We might be due for a big correction but as ex-Citi CEO Chuck Prince famously said in 2007:

"As long as the music is playing, you gotta keep dancing"

So, we continue to buy 50x PER names and not worried about just getting 2% earnings yield even though it doesn't make sense any more because risk free rate (or yield) is now 3-4% in the US. Interestingly, we can buy Chinese banks at 5x PER and receive 6% dividend yield but no, investors will still prefer 50x PER concept stock in the US rather than invest in China.

Many global investors believe that China could be an un-investable market as long as Xi continues to rule with an iron fist with the wrong advice and motivation from his top echelons advisors and inner circle. While he is not Putin, he needs to be more pragmatic and focus on the economy rather than his ego and China needs to return to the pre-pandemic days of embracing innovation, restore diplomacy and providing entrepreneurs freedom to grow their business domestically and then expanding globally to challenge western rivals.

Let's hope that can happen.

Huat Ah!

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