What a week!
It felt like March 2020 again – but for China Tech stocks only.
I shared my views on the China Tech Crackdown on Monday, and I received amazing comments from all of you.
Whether it was on Facebook, email or the comments section, I’ve read through every single one of them – and I wanted to share updated thoughts in this post.
Lots to cover, lets go.
BTW – We just launched a national day promo for FH Investing Courses. Want to learn how to invest seriously? Check it out here!
China Tech Crackdown Update: What happened the past week
Update from the past week:
Monday – Rumours leak that Tencent is next in line to be regulated (to open up their WeChat ecosystem).
Tuesday – Tencent announces they are suspending user registration on WeChat “to align with relevant laws”. Tencent closes down 10%, as do most other Chinese tech stocks.
Regulators announce they are also looking into Property Management Companies, to bring down house prices.
Wednesday Evening – Regulators arrange a call with Chinese investment banks and funds. The message is not to worry about the regulatory crackdown on Edutech.
There are rumours that government linked funds have started to buy to stem the fall.
Thursday – State run media in China talks about the sell-off being overdone. Regulators mention that they are open to “other listing destinations”. Meituan closes up 15%.
Friday – The sell-off resumes. Most China stocks fall between 3% – 8%. SEC freezes all Chinese IPOs in the US, calling for increased disclosure requirements.
Here’s a chart of Meituan’s price action to round up the roller coaster week. That’s an unbelievable ~30% trading range.
FH’s take on tech crackdown
In my Monday article, I shared my view that the crackdown was to force China tech companies to comply with 2 rules:
- Rule 1 – Comply with national strategic objectives
- Rule 2 – Sustainable competition (no anti-competitive practices)
If you haven’t read it, go and read it now. It sets the background for the discussion today.
TLDR version – check out our Instagram for a summary.
Just like Monday, I’ll structure the rest of this article in a Q&A format.
I’ll split it into the macro framework (big picture), and the micro stock level analysis (small picture).
Macro Framework – the Big Picture
What is an alternative reason for the China tech crackdown? A deeper, darker interpretation…The Darkness of Mankind
I received a very good comment from a China tech veteran.
He suggested that I may be looking at this all wrong. That there is no deeper, underlying goal to the crackdown. And that all this is done simply because some politicians want to retain their hold onto power.
I’ve encountered this view in the past. It’s especially prevalent among the older generation who lived through the cultural revolution.
I suppose once you live through an event like that, it changes you for life. And you can never forget the darkness of humanity – what lengths humanity will go to for self-preservation.
I myself have never lived through the Cultural Revolution, so I concede I could be wrong on this.
But I choose to believe in the goodness of mankind.
My personal view is that the CCP is not stupid. They know that the best way to retain power, is to rule China well. It is to deliver on economic growth, geopolitical power, solve demographic issues, solve social issues. They will try to do it the right way first, only if it fails do they default to a darker path.
But like I said – I recognise I may be wrong on this.
If you subscribe to this alternative view, then there is no greater purpose to the crackdown. It can be purely arbitrary, with the rationale created in hindsight.
Today it’s Didi, tomorrow it’s X CEO that Beijing views as a threat.
Yesterday it was the “Anti-corruption campaign” to remove political opponents. Today it’s a “Tech Crackdown” to take out prominent businessmen.
If you subscribe to this view, then China is basically uninvestable.
Whether you believe it or not, you need to recognise this is a risk of investing in China. This is not the US with its Rule of Law and checks and balances.
Why is China doing this? Doesn’t this hurt their long term competitiveness by stifling innovation?
Yes – but China doesn’t care.
China has never cared, all throughout 5000 years of her history.
In 5000 years of history, the only thing the ruler of China has ever cared about is securing their hold on power. Watch the 宫廷 (China palace drama) shows sometime. There’s a lot of truth in there.
China is such an incredibly dynamic and vibrant land, that as long as you can secure power and create a stable system – the country will flourish.
Create peace and stability, and the 老百姓 （common people） will innovate, and commerce will thrive.
Look at the crypto crackdown. Sure, it will disconnect China from the blockchain revolution, and set back innovation for years to come.
But China doesn’t care. They only care about retaining power.
Which is why the darkness of mankind interpretation above, scares me so much. We could all be reading China completely wrong.
Is China doing this to kill the 2C business? To refocus talent into the Military-Industrial complex?
This view is more common among the westerners.
They see this as a soviet cold war style action – with China trying to cripple the 2C (to consumer) business, and bring talent into the military industrial complex.
I don’t agree with this one.
If you look at the five year plan and state messaging, it’s clear that driving domestic consumption is a big goal.
Heck, eCommerce (淘宝) is touted as one of the 4 great modern innovations of China (alongside Alipay (支付宝)，high speed rail (高铁)，and bike sharing (ok the last one didn’t turn out so well)).
In any case, this “talent” they speak of is mostly front end stack developers.
You don’t take a UI developer and turn him into deep learning AI researchers overnight.
What is China’s Endgame?
To better understand the Chinese Communist Party (CCP)’s end game, we need to look at China’s 5 year plan.
Think of this like a blueprint set every 5 years, that determines the direction for China over the next 5 years.
Lillian Li did up a great summary that I’ve extracted below:
My 2020 to 2025 Five Year Plan narrative is the period of the Great Reshuffle.
Similar to how on-premise enterprise software that gets by on license sales eventually switch to the cloud and recurrent billings. From the outside, the firm will see a few years of flat or moderate growth, but internally, they are re-architecture the bones of the place, shift emphasis from one department to the next and spin up new cloud divisions that weren’t there before. Theoretically, when the pivot is complete in a few years, they will be ready for more growth.
Aspects that marked a departure from prior FYP (and therefore emblematic of a reshuffle):
- The lack of a concrete GDP target while others do have concrete number targets
- 35% of indicators are about social welfare, indicating a rebalancing toward social factors
- Shifting of achieving GDP via service sector to GDP via high tech industries (manufacturing and innovation)
Given the difference in emphasis, I think China aims to reshuffle from an export-led, light manufacturing base that prioritises unequal growth to a consumption-led, high-tech manufacturing-based, low-carbon country (with sustainable fertility rate).
TLDR – The shift is away from a fixed GDP target, to more social factors.
The latest reports suggest China wants to move away from the US model, and towards the German model. This means less financialization, and more manufacturing.
Exactly in line with the 5 year plan.
BTW – we share commentary on financial markets every week, so do sign up for our mailing list.
Micro Level Analysis – the Small Picture
That’s the big picture – now we go into the investing level questions.
Would I buy blue chip China tech stocks like Tencent and Alibaba now?
Yes, and no.
Think of it like March 2020.
The sell-off hit all stocks across the board. Everything dropped.
Then the Feds stepped in.
But the recovery was uneven. Some sectors like eCommerce (Amazon) and Streaming (Netflix, Zoom) benefitted very strongly from the pandemic. Some sectors like airlines and hotels were decimated.
I think this is the same, only that this crisis is man-made.
The CCP wants to build a new future for China, a new blueprint. We need to understand what the post-crackdown China looks like.
Then we need to decide how each industry, and each stock fits into the broader picture.
In other words – we need to find the Amazons and Zooms of the post-crackdown world. And do it fast (before it’s priced in).
So the answer to this question is not so simple.
Sure, as a short term trader you just buy the dip and trade the volatility. But as longer term investors we need to understand the long term picture.
New information is coming to light everyday, that gives us clues as to what the endgame is. What started with Ant Financial was only the beginning. And by that logic, what we are seeing today is unlikely to be the end.
Are China ETFs good? Which ones to go for?
ETFs are good if you’re lazy and don’t want to stock pick.
But a note of caution – the China market is not as efficient as the US.
China is still early in their development, a lot of the great companies are still private, and a lot of industries are in the consolidation phase.
When you buy China ETFs, don’t expect something as efficient as the S&P500 or the NASDAQ. It’s more like the STI ETF.
Good ones to consider include MSCI China, Hang Seng Tech, FXI etc. None is perfect though, each has its own pros and cons. I shared more views in a recent article here.
Would I buy non-tech China stocks like Ping An or Anta now?
China is a very big and complex market.
The equivalent is asking if Nike is a good buy if Trump goes after Amazon. Sure – but the link between the 2 events is weak.
I like China, and I’m very bullish on China with a decade long horizon.
But really – every industry is different, and needs to be analyzed on its own merits.
Banks (ICBC, CCB etc) – their book value is a giant black box. Nobody knows the true value of their loan book. With China clamping down on real estate, a lot of loans may go bad (China banks have a lot of real estate exposure). But if you believe the CCP will prop them up, then you’re buying in at 50% discount to book and a 7% dividend. It’s a leap of faith.
Consumer Discretionary (Anta, Lining, HLA etc) – Fast fashion is a brutal industry. If you catch a stock on the upswing, the gains are massive. But you need to be very in tune with consumer tastes on the ground. Trends move especially quick in China.
You get the idea. You need to run the analysis for each industry. Very tough to generalise.
Is Tencent Music (TME) still a good buy? Has their moat been eroded?
Think of the Netflix evolution.
They started out by paying for content, and streaming it for a fee.
Over time, their competitors caught on, and demanded higher fees / refused to share content.
So Netflix had to create their own original content, which is the only true moat in the longer term. Own the content, own the user.
Same for Tencent Music.
They’ve built their empire today based on music exclusivity. Foreign music brands can only sell to me, not to my competitors. Consumers have no choice.
Going forward, that playbook is thrown out of the window.
Going forward, if you want to create a moat, you need to create original content.
Exactly what Netflix did, as did Spotify.
Tencent Music will need to evolve accordingly, and they’ve been investing big in original content the past year.
User base wise, they still have a big lead over the No.2 player, Netease. And they have backing from Tencent.
I wouldn’t count them out just yet.
Where would I put new money today – US or China?
I penned an exclusive Patreon article recently sharing that I’m worried about 2H2021 for stocks.
I think that:
- Credit impulse peaked in 2H2020 (lag time of 9 – 12 months means it hits in 2H2021)
- Fiscal + Monetary stimulus will taper going forward
- Real growth is starting to peak
With US tech at this kind of valuations, didn’t hurt to lock in some profits. So I sold some of my US tech recently.
China tech is about 10% of my stock portfolio today. US Tech Software is about 20% (Full Breakdown on Patreon).
With the recent China tech sell-off, and with US tech at this valuations, I might rotate some of my freed up funds into China tech. With a long term perspective.
Closing Thoughts: Is the crackdown over?
It’s been a monster of a post, and my apologies if I didn’t manage to cover all of your questions.
Any burning issues – just leave a comment below and we can continue the discussion.
What is clear – is that the regulatory crackdown is not over. Not by a long shot (in my view).
What started with Ant Financial was just the beginning. And likewise, what we see with Didi, Tencent and Edutech today, is unlikely to be the end of it.
CCP looks to be serious about reforming tech. Alibaba and Tencent have moved away from their golden days of value creation, into value extraction. The are no longer driving growth, they are impeding growth and development. And all that is likely to change going forward.
Like Lillian Li said, this is the period of “Great Reshuffle”.
Short term pain – to set up China for the new phase of growth.
As a long term investor, I think some caution is warranted.
Like with the Ant crackdown – it started in Nov, and even today it’s still playing out. I don’t think this crackdown on Didi or Tencent etc will be over so soon.
I will likely be adding to my China positions, but when, which, and at what price I haven’t decided. You can follow me on Patreon for regular updates when I do.
I would love to hear your thoughts – what am I missing here?
BTW – We just launched a national day promo for FH Investing Courses. Want to learn how to invest seriously? Check it out here!
As always, this article is written on 31 July 2021 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patreon.
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