China's Red Chips Crisis: Red Flags Alerts !

While China's stock market valuations might appear attractive to investors, a closer examination of the underlying factors suggests that now may not be the ideal time to dive in.

Several key considerations, including geopolitical tensions, economic uncertainties, and market dynamics, paint a complex picture that warrants caution.

(1) Foreign Funds & Old Monies’ Absence.

One of the most significant indicators of a market's health is the inflow of institutional investment, particularly from established US funds.

Currently, this crucial source of capital remains noticeably absent from Chinese markets.

• Based on HK’s SCMP on 11 Jan 2024, China saw $34 billion equities outflow, a show of weakened confidence even as other emerging markets saw notable inflows. (see above)

• Based on UK’s Financial Times on 19 Aug 2024 new report, $12 billion have left the Chinese market since June 2024. (see above)

The persistent outflow suggests a lack of confidence from seasoned investors, which is crucial for sustained market growth.

(2) International Demand - No Show.

The global pandemic significantly impacted international interest in Chinese equities, and this demand has not fully recover.

• The MSCI China Index, which tracks large and mid-cap Chinese stocks, is still down about -40% from its peak in February 2021. (see above)

• Foreign ownership of Chinese A-shares has decreased from a peak of 4.3% in 2020 to approximately 3.1% in early 2024, according to data from the People's Bank of China.

(3) Strain US-China Relationship Remains.

The ongoing tensions between the United States and China continue to cast a shadow over Chinese equities.

• Trade tensions: Despite some progress, the US-China trade deficit remained high at $279.4 billion in 2023, according to the US Census Bureau. (see above)

• Technology restrictions: The US has maintained its stance on limiting China's access to advanced semiconductors and related technologies, impacting key Chinese tech companies.

• Geopolitical issues: Ongoing disputes over (a) Taiwan and (b) the South China Sea continue to strain diplomatic relations.

(4) China's Economic Challenges

China's economy faces several headwinds that impact its growth trajectory and, by extension, the attractiveness of its equity markets.

• GDP Growth: China's GDP growth rate for 2023 was 5.2%, below pre-pandemic levels of 6-6.5%.

• Property sector crisis: The ongoing issues in the real estate sector, exemplified by the Evergrande crisis, continue to weigh on economic growth.

• Debt concerns: China's total debt-to-GDP ratio reached 281.5% in 2023, according to the Institute of International Finance, raising concerns about financial stability.

(5) Short-lived Impact of Government Measures

Recent measures introduced by the Chinese government have served more as fodder for short, sharp spells of speculation rather than sustainable growth drivers.

• The reduction of stamp duty on stock trades from 0.1% to 0.05% from July 2023 resulted in only a temporary +1.9% increase in the Shanghai Composite Index.

• The subsequent 1 trillion yuan ($137 billion) rescue package announced in late September 2024 led to a brief +5.3% surge in the CSI 300 Index.

• The speculative rally peaked on 08 Oct 2024 before the gains were largely erased thereafter. (see MSCI chart at point #2).

These interventions have failed to address underlying structural issues, leading to quick fizzling out of market rallies.

My viewpoints : (mine only)

China is stuck in many unenviable “egg and chick” situations.

(1) Property and Old money.

Without resolving the property crisis that has dragged on long enough (in China), old money will not return.

Without foreign funds entering the market to boost the economy, it will be difficult to rely on local support, where the mass majority are not exactly millionaires, unlike US stock market.

(2) Cooling GDP.

According to China's National Bureau of Statistics, on an annual basis, China’s gross domestic product (GDP) rose by +4.6% in the 3 months to end Q3 2024.

China's economy expanded in Q3 at the slowest pace since early last year, as the country struggles to boost flagging growth.

Incidentally, this is the 2nd quarter in a row that China's official measure of economic growth has fallen below the 5% target.

This is further-confirmed by $LVMH-Moet Hennessy Louis Vuitton(LVMUY)$ in its Q3 2024 earnings when the World’s #1 luxury conglomerate revealed that China’s economic slowdown hits LVMH with -16% drop in regional sales.

(3) Chinese Fizzles.

After the stimulus packages enacted in July and September in quick successions, Chinese stocks reacted “favourably”, only to peter out as it was unsustainable as it was not underpinned by a strong economy. (see above)

$Alibaba(BABA)$ a “former darling” of both Wall Street and HK exchange had a steep stock price ascend around 25 Sep 2024, peaked in early October and then trended down, just as quickly.

It is the same story for other dual listed Chinese stocks like $PDD Holdings Inc(PDD)$ , $Tencent Holding Ltd.(TCEHY)$ and $JD.com(JD)$.

The punters’ force of nature is not something even the ruling government could be controlled without the risk of permanent damage should a high handed approach be taken.

GungHo Burry.

In my post dated 23 Aug 2024 (click here ! to read !) I have noted with skepticism when legendary investor Michael Burry pivoted his holdings to predominantly Chinese stocks.

I did not marvel at his investment strategy.

As the saying goes, “hindsight is 20/20” - so going forward, there is definitely even more “trust” and respect for this man.

Did Mr Burry perform a 100% exit stage left on 07 Oct 2024 at the peak of Chinese stocks rally ? Curious to find out !.

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