When the China joined the World Trade Organization in 2001, an up-and-coming economy soon became an economic powerhouse with dynamic 6-10% plus growth in GDP year after year. The Chinese stock markets became the market of choice for many foreign investors to take their money for great, and sometimes outsized, returns. For sundry reasons this enthusiasm has slowly but surely died out. Numerous investors have been burned or stung with the decline of capitalization in Chinese security markets, and there has been some dismay at what has happened to the overall economy. But the question remains will the Chinese economy revive itself, and if so, then when?
The “Got-Rich-First Group: During the early boom era smart investors in China were well positioned to profit from the dramatic growth in GDP. This was not only the well-to-do, but middle class and up and coming investors who managed to make money with their jobs or businesses and had the savvy to save and invest it. Those investors fell into a classification known as the “got-rich-first” group. The investments varied, but most commonly the got-rich-first group put their chips into real estate and the stock markets either directly or through a fund. Much of the GDP growth in those days came from the import/export sector, and with the favorable balances the money rotated into China’s property industry in a massive building boom. The outsized returns reached the 20-40% range. As returns like these had never been seen before in China, they soon came to be expected by the got-rich-first group. But a string of good years of growth oftentimes can be followed by a string of less than good years. Then along came Mr. Xi Jinping whose ideas about wealth accumulation were different from many in the got-rich-first group. From 2013 to 2018, Mr. Xi’s first term in office, personal income from investments was 10.8%; during his second term that percentage fell to 7%, and so far during his third term that percentage has fallen below 5%. Along with the decline in real estate values came the decline in stock market values giving the got-rich-first group a hard swath with a double-edged sword. Monies invested into trust funds for future cash flow (such as annuities) were often invested by the fund into riskier assets than what would ordinarily be called for by the asset class. This led to a rash of trust fund defaults leaving the investors with huge potential losses. The government has not stepped up to provide bail out insurance for the failing funds, and the legal profession advises that pursuing legal action would be useless. The state’s track record shows some support for the poor who lose out, but not for the got-rich-first group. To add to their misery, about one third of white-collar workers, either in the got-rich-first group or wannabes, were forced to take pay cuts over the past year. The has resulted in a trend towards investing in safer assets by the got-rich-first group thereby making the already risky existing real estate and stock ventures even riskier.
Consumer Sentiment: If the Chinese economy has a failing growth engine, the solution may rest with increasing consumption. The Chinese consumer typically spends less of his/her income on consumer goods than counterparts in other economies worldwide. Some studies have shown that for the economy to turn around, the consumption sector must increase by at least ten percent. History shows that such a phenomenon does not occur often; and if it were to occur once in the immediate future, it could stall out in ensuing years causing growth to slip again. Chinese society provides its consumers with very little in the way of social protections and security. Benefits such as unemployment insurance, retirement benefits, and welfare are rare or non-existent. In China, workers are registered for hukou, a household registry, in the town or city where the individual is born. But many workers have become internal migrants, moving away from their ancestral villages to larger urban environments where jobs are more plentiful. However, the migrant worker has a more difficult time accessing schools, hospitals and other services in the city where he/she works owing to their out-of-town hukou. Housing as a percentage of income is likewise an extraordinarily large amount for many workers. But in all-too-many cases the home buyer has been stiffed by the developer who has accepted payment for the house or apartment, but is unable to deliver the home for use. There is little or no legislation protecting migrant workers in particular from not getting paid by their employers on a timely basis. The only labor unions permitted are those that are state-owned, and these unions will sometimes side with employers in wage disputes. All these issues and more have resulted in the Chinese consumer being very careful about spending in the near term and maintaining reserves for emergency purposes, such as being locked down during a pandemic. The talk in official circles about rebalancing the economy enabling consumers to participate more has gone on for twenty years, but the consumption sector remained about 52-55% of GDP during that time span, compared to 72% for the world as a whole.
Falling Stock Markets, Failing Economy: Conditions in Chinese stock markets have gone from so-so to worse in the past two years declining by over 20%. This is compounded with the dismal outlook for the overall economy owing in a large part to the real estate sector’s disastrous performance. The attitude among financial managers—asset managers, insurers, and private equity bosses—is strictly bearish. The average citizen looks upon the economy as having never recovered from the dismal pandemic years. There are as many as 200 million stockholders in China, and the backlash of a falling stock market can be seen in social media. The government should also be highly concerned as stock market results impact what foreigners think about China’s top leadership. There have been a few geopolitical positions that are troublesome such as the zero-covid lockdowns and support for Russia in the Ukraine War, but by far and away the worst impression is that nothing adequate is being done to fix the real estate debacle. Consequently, foreign investors are bailing out, and in some cases even shutting down their offices and operations in China. To make matters worse, most foreign investors do not picture a turnaround any time soon. They are likely holding back until they see a major improvement in the real estate markets—a situation that may require several years to rectify. There is also hope that the government will step up with a sweeping bailout of some kind, but so far nothing of that sort has happened.
Market Regulators—Referees or Managers: This overall bleak picture brings up the role of the different government regulators in the Chinese economy. Do they work as enforcers charged with the responsibility of carrying out the policies and positions of senior leaders, or are they more like managers charged with doing whatever they see fit to manage what takes place. In the United States, policy is only enforced by regulators. The head of the China Securities Regulatory Commission (CSRC), a Mr. Yi Huiman, was abruptly fired February 7th of this year. His predecessor was similarly fired in 2019 and placed under investigation for corruption. The boss before him was made to be the scapegoat for the market crash of 2015. In all three cases the head of the commission was dismissed during a stock market pullback making it apparent that it was his responsibility as a regulator to prevent such a thing from happening. If so, it could well mean that each one had the authority to take major action of his own choosing to rectify the adverse market situation, when in reality it was a combination of various factors outside the realm of the markets that was responsible for the declines. Other actions or pronouncements by the CSRC are in themselves causing problems instead of generating solutions. In 2012 regulators put a stop to all IPO’s being issued to preserve liquidity for supporting stock prices. This drastic action caused the queue of IPO’s to build up until over a year later in 2014 when the ban was lifted. The onrush of IPO’s caused an historic rally followed by a sharp crash. On this February 4th, the CSRC said it would crack down on “malicious short selling.” This would mean that hedge funds and other traders that took advantage of short selling would be forced out of the marketplace altogether. It’s further feared that the government will take actions to steer the markets into directions that top policy officials want to see. Chinese officials want the valuations for state owned enterprises (SOES) to be raised to the levels of their private industry counterparts. This is desired in spite of the reputation that the SOES have for disregarding investor relations, and not using return on equity as an internal performance metric.
Conclusions: This may be the worst time in recent history for foreign investors to bring their investment money to Chinese markets. The Chinese government has a long way to go before the real estate fiasco will level off much less turnaround. It is a mess of their own making. With this major obstacle unresolved, and currently unattended to, foreign investors would be best served to make their investments elsewhere.
Sources: The Economist, Dissipating Dreams, February 10, 2024.
The Economist, Spend More Please, February 10, 2024.
The Economist, Fanning the Flames, February 10, 2024.