I received a couple of questions recently that I wanted to address.
They are:
- When to sell China stocks?
- Start of a new bull market for US?
When to sell China stocks
So I received this question recently:
Hi FH, would like your thoughts on China stocks.
About a year ago, you gave me the advice not to sell China stocks that had already been beaten down, especially if one believes in the long game.
One year on, given current developments in China and globally, would you change your advice?
Where I’m coming from is this.
Your opinion is a soft landing is unlikely.
So stock prices can go lower still in the short to medium term.
In addition, the situation in China (Covid, Credit, Crackdown) continues, making China companies less attractive, which means recovery, if any, could take far longer than expected.
And so, even if one is sitting on some losses, I’m wondering if its prudent to cut ones losses and divest somewhere else.
For example, every year a 100k sits in a chinese stock trading sideways, is a potential 5% in dividends in a reit.
And that can add up quickly.
Appreciate your thoughts!
My Response – Start by looking at the downside
Okay first off – I cannot give advice that is specific to your situation.
Every investor is different – their age, their income, family, investment objectives, asset allocation etc.
This affects risk appetite, and consequently investment decision making.
All I can do is to share what I would do, and you can decide whether that applies for you.
What I would say though, is that when you invest, risk management is always the first thing you think about.
If you cannot accept the downside, then the investment is not one you can make. In which case you sell the stock, no questions asked.
Once you manage risk, the upside takes care of itself.
For me personally, my current China exposure is about 2% of total net worth.
It has come down because of the decline in prices, and because I have not been adding to China positions for almost a year (I did add a small position to ICBC recently).
This means that if China goes the way of Russia and the investments are completely written down to zero, that’s something I can live with. Sure it hurts, but it’s not going to affect my day to day living one bit.
You need to decide if the same holds true for you. Only then should you start thinking about upside.
Thought process from one year ago
A year ago, the outlook for China was unclear as to CCP’s end goals for the tech crackdown, and what the tech landscape would look like post-crackdown. There was uncertainty over the real estate crisis, and “common prosperity”.
At the same time, US inflation was raging very high, which led to a high probability that the Feds would tighten US monetary policy aggressively going forward.
Because of that, my thinking was that it did not make sense to lock in losses in China stocks to move over into US stocks – because one would be selling out of China stocks (which had already suffered losses), to buy US stocks (which had not yet suffered losses).
Fast forward one year
Fast forward one year, and the entire global macro landscape has changed.
On the China front, we now have a lot more clarity on what the tech landscape is going to look like post-crackdown – basically a shadow of its former self.
At the same time, China’s insistence on COVID-zero at least until the Party Congress, as well as their ongoing real estate crisis, is a serious dampener on China’s economic growth.
There is limited policy easing coming out of the PBOC, but none of the torrent of liquidity required to save the China economy.
At the same time, many institutional investors from Temasek to Bridgewater have already exited their China positions entirely or pared down quite significantly.
All while it is clear that the US-China conflict is going to play out over years and decades, so China stocks will require a geopolitical risk premium going forward.
At the same time, tightening US monetary policy has triggered a re-rating in global financial asset prices. The violent decline in multiples has already happened, but the slowdown in earnings and rise in refinancing risks will still take time to play out.
What am I doing?
My China positions can be broadly split into 3 camps:
- Tech
- Banks
- Real Estate
Tech
I am still holding my tech positions.
At current valuations, I frankly don’t see much point in selling them, especially when most of the institutional investors have already exited.
That said, I haven’t been adding to China tech positions for almost a year, and I don’t see any reason to change my mind until I see meaningful changes in the China policy towards Tech.
Without change on the policy front for tech, or on the stimulus front for the China economy, it’s hard to see any fundamental catalyst for China Tech.
But to be fair, this is a small portion of my overall portfolio, and I do not need the funds urgently, which is why I am able to make this decision.
If the same does not hold true for you, I can completely understand why you may want to close China tech positions.
Banks
I have been adding to my position in the Big 4 China banks though (I hold CCB and ICBC). These are small positions, that I am prepared to write off completely if things head south.
But at current prices, they do offer 8.5% dividend yields which to me is attractive enough given that I would expect CCP to backstop the Big 4 banks (CCB, ICBC, ABC, BOC).
Real Estate
My way of playing China real estate is via CapitaLand China Trust, which trades at about 7%+ yields.
I think if you want to try your hand at China real estate the key risk is refinancing risk, so you don’t want to touch any of the onshore players.
CapitaLand to me has the financial muscle such that CLCT wouldn’t have any refinancing risk, which gives me the confidence to hold this as a long term play.
That said at current prices I’m also not adding to CapitaLand China Trust, because I don’t think valuations are attractive enough given the ongoing real estate meltdown in China.
Especially not when US interest rates are going to continue their march up towards 3.5% by end of the year.
My views on China?
I agree China stocks require geopolitical risk premium this decade.
The US-China conflict is not going to stop, and investors not comfortable with that should exit.
Think Pelosi in Taiwan, and expect much more of that this decade.
If that’s not something you can live with, you may be better off just exiting entirely.
We’ve already seen many major investors like Bridgewater significantly pare down their stakes.
Personal view though – I still think there is value in China, especially at the right valuations.
You just want to be very careful about position sizing.
Should you sell beaten down China positions to buy REITs?
To answer this question will depend on (1) what is the China stock you are selling, and (2) what is the REIT you are buying.
On (1), I think maybe with tech it might make sense to sell on bounces. For banks/real estate, I think there could be room for recovery as long as you’re holding the right names and have holding power.
On (2), simple view is that I don’t think the sell-off in global assets is over just yet.
So the comparison is not as straightforward as buying a REIT and making 5% a year. There could very easily be capital losses for REITs in the short term.
That’s why market timing is tricky, because you need to get both the buy and sell timings right.
But I know certain traders / investors who when they are down they like to close off all their positions completely as a way to “reset” their mind.
If that’s you, by all means go ahead.
Start of a new bull market for US?
Which brings us to the other question.
I’ve been hearing so much talk about a new bull market for US stocks.
You know, NASDAQ being up 20% and all.
Personally I don’t subscribe to this.
I still see this as a bear market rally within the context of a broader bear market.
Many of the arguments I have already shared in previous macro posts, so I won’t belabour them.
The way I see it:
- Market was always mispricing recession risk in 2023 – Wage growth is still strong, so the economy is not near rolling over just yet – which means a rally in risk assets like this was overdue at some point
- Because the economy is stronger than expected – there is no need for the Feds to cut rates in early 2023 as the market is pricing in – Feds can hike to 3.5% by year end, and keep it there while evaluating what happens next
- This means the decline could take some time to play out, as interest rates at 3.5% and QT start to work their way through the economy via lower earnings and refinancing risk
What I would update, is that based on last week’s inflation data, there is actually a possibility of a soft landing here.
If the Feds do 50/25/25 over the next 3 meetings, taking us to 3.5% by year end – that allows them to pause there and decide whether to hike another 25 bps or pause based on inflation data.
Whatever the case though – the way the macro is set up, I’m prioritising capital preservation over capital gains here.
I’m sitting with almost 25% of net worth in cash or cash equivalents. That’s almost the same amount as I have in stocks/REITs/Commodities etc.
Which frankly isn’t all that bad given that we’ll be looking at 3%+ yields on cash by end of the year.
Between 3% risk free on a T-Bill and 5% on a REIT, I actually think the former looks pretty attractive in this climate.
It gives me peace of mind, and it lets me watch the macro play out with much of my capital intact.
And worst case if I am wrong, I will buy when the Feds make clear that they are cutting rates.
I have not sold my core positions so I am still benefitting from the current rally.
As always – love to hear what you think!
Seems like more and more of your articles are behind a paywall these days.
I can’t access this but actually I am more inclined to do the opposite – buy currently unloved China stocks and sell US stocks into current rally which I feel is a bear market rally which will head down before too long.
Hi CMC,
Haha actually these articles were always paywalled under Patreon – only difference is that I started sharing them on the FH main site recently.
Anyway just for your benefit, the conclusion was pretty in line with what you just said. I too, see this as a bear market rally for US stocks. For China though, I think the picture is a bit more nuanced. China is going down a pretty dark path and the short term looks bleak. But they do have a lot of levers they can pull (for eg. fiscal and monetary policy, capital controls, state directions etc). And with more foreign investors exitting China, downside may also be controlled. With the right position sizing and risk control, China could be an interesting investment, with a lot of diversification benefits in the months ahead given how it trades on a different credit cycle from the West.
Geopolitical risk premia is a big tail risk to be aware of though.
Yah, for China, there is only one question in my mind – will the US and increasingly rest of West be successful in crushing it or not? If China is crushed, then it will be a long period of stagnation. If not, then there is no stopping the long term appreciation of Chinese assets. There is no reason why GDP per capita of mainland China should be lower than HK, Taiwan, Korea or Singapore for that matter. So if it catches up even part of the way, the upside is enormous. But it could get crushed. Japan was crushed by the US when it became too strong a competitor and now decades later, it has still not recovered its mojo.
Agreed. Although China has enough real domestic challenges of their own, that even without the US they might very well self-destruct by themselves!
For what it’s worth though, China is well aware of the mistakes made by the Soviet Union and Japan, and they are trying desperately to avoid the same. Remember that Japan lost a whole decade because of their real estate bubble, and never really recovered after because of demographics. China is well aware of the risks of going down the same path. That said – knowing the problem, and solving it, are 2 different issues!
Japan was crushed because
– it was smaller in size (the only developed Asian country vs the West).
– It is an occupied country since WW2. Still is today. Arguably not 100% sovereign as it trades off its dignity and decision-making for US security.
– Plus there was this plaza accord which boosted US exports and harmed Japan. People often forget to mention this.
– a xenophobic ageing population that can hardly attract talents. Closed society.
China has always been a different animal: its population is > japan+russia+US+EU combined. Too big to be crushed. Ageing population also not really a big issue: who says u need 1.4bn to be the top dog? All developed countries suffer from ageing population. The US birth rate has been dropping for many years.
US probably still the top in ability to attract talents but China is catching up rapidly. Plus China has a huge pool of educated engineers and scientists whereas education is on the decline in the US. If you look at recent achievements in space and tech, they can depend on themselves to move upwards technologically. They just need the time. Also note that some of the top tier researchers in the US are Chinese / non-americans. If anti-asian sentiments persist, some of these Chinese may go back to China. See FBI’s witchhunt.
Us suffered a great depression in the 1920s before becoming a super power. There were many crises along the way. Who says every journey is smooth? China may be going thru some challenges but too early to determine the outcome.
How many more crises can the US tolerate before greatly weakened? Politically getting more unstable . Trump supporters attacked FBI and capitol. This is the start of societal unrest, more to come in the future.
On another note, EU will trigger a global recession. Why didnt you talk about this?
In the future i predict breaking up of EU— it was already partially broken with Brexit. Where will China be? I dont know, it just needs to bide its time and hang on for survival to be the ultimate winner.
China took up a lot of debt in the past 40 years to rapidly modernize and build infra. It literally built itself out of poverty but in the process constructed many ghost cities. This was a necessary devil for high economic growth. Now Xi has recognized the need to tame this and cut down the debt and clean up other things. Not sure Whether they can manage this well. Economically, chinese are known for high savings (wealth hoarding) and not as consumerism as US. So it can be quite difficult to grow the economy thru consumerism alone. The government know this and recognize this to be both a strength and weakness. Thus the need to bolster trade via belt and road which has other benefits like reducing reliance on the unreliable west and promote use of alternative settlement currency.
I think if China is going down(getting crushed), let’s not forget they have some leverage as well. They may be forced to ban imports of foreign goods as a last resort. Eg german and US cars. Starbuck. Apple phones. Microsoft software . There are cheaper viable alternatives to these products. Corporate earnings will drop. Let’s not forget these US corps rode on the back of China’s growth. Hack, they are gradually moving away from foreign tech by making their own cars, baterries, chips, GPUs, enterprise software etc.
They may also ban rare earths export. Cut taiwan’s sea cables and completely encircle and isolate it u til they surrender and give up TSMC.
They have been completely isolated before in the commie era. They can tolerate isolation from the west again as the last resort. This time the difference is that It will still trade with friendly/neutral countries so it still has some buffers. But the west imports so many important products from china that it is actually the west that cannot afford to sanction china.