China's Blue-Chip Stocks Offer Attractive Valuations: Buy Baba, JD, Tencent, Ping An, and BOC?
China is already grappling with significant domestic challenges: a local debt crisis and a property market in turmoil. However, the looming impact of heightened tariffs presents an even graver concern. While many investors remain optimistic about Chinese stocks—betting on a "bazooka" stimulus from Beijing to revitalize the economy—it’s vital to consider the broader risks, particularly political ones. Stocks like Alibaba and JD have reported solid profits with low price-to-earnings ratios, and major Chinese banks such as Bank of China and Ping An Bank offer appealing dividends and seem fundamentally robust. However, this perspective often overlooks the risks posed by geopolitical tensions and economic uncertainties.
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Some argue that the global supply chain and manufacturing bases remain heavily reliant on China. Chinese products continue to find strong markets in regions such as Southeast Asia, India, Russia, Saudi Arabia, Brazil, and Argentina, even as the U.S. attempts to decouple and shift its supply chains. However, fully bringing these industries back to the U.S. seems unlikely. Instead, the U.S. may end up sourcing these products through intermediaries at higher costs, potentially fueling domestic inflation—a scenario often likened to "hurting oneself more than the opponent."
The key consideration in this debate, however, is not just where Chinese products can be sold, but how much can be sold and at what price. For instance, a toothbrush might sell for RMB$2 in China and USD$2 in the U.S., but in the Middle East, it might fetch only RMB$3—a price that leaves little profit after production and logistics costs. This highlights the necessity of targeting high-value markets like the U.S. or Europe, where consumers are willing to pay higher prices, making exports more viable.
Shifting exports to other regions isn’t always a practical solution due to differences in demand and affordability. Products tailored for the U.S., Europe, or Japan are often priced too high or are over-engineered for other markets. Similarly, redirecting export goods to the domestic market—a strategy known as "export-to-domestic transformation"—has proven equally challenging. Historically, the best goods are allocated for export, leaving the domestic market with lower-quality options that must compete with a vast number of local suppliers, often leading to undercutting on price.
Even with the rise of a middle class in China, attempts to sell export-grade products domestically frequently fail. High costs, differences in consumer expectations, and unfamiliarity with domestic market operations all play a role. Moreover, companies venturing into domestic trade often face risks like nonpayment and fraud, discouraging further efforts.
These complexities highlight that global trade dynamics are far more intricate than they appear. Simplistic assumptions—such as redirecting exports to other regions or the domestic market—often ignore the challenges of pricing, logistics, and consumer demand. These factors make it clear why adjustments, such as significant RMB devaluation, could remain a strategic consideration for China in navigating this evolving landscape.
The Looming Impact of Tariffs
Economist Brooks, writing in the Financial Times, noted that if U.S. tariffs on Chinese goods were to climb to 60%, the yuan would need to depreciate by at least 50% just to maintain current export levels. This scenario assumes no retaliatory tariffs from China—a key point because Beijing's ability to fight back is inherently limited.
If the yuan weakens significantly, the exchange rate could break beyond 8 or even approach 10 yuan per dollar, which would create significant shockwaves for the Chinese economy. Although this forecast may sound alarming, it is grounded in economic realities.
China's Limited Options for Retaliation
China’s arsenal in a trade war is asymmetrical. While the U.S. can target a wide array of Chinese exports, China’s ability to impose effective retaliatory tariffs is far more constrained:
High-Tech Imports: China relies heavily on U.S. exports of precision equipment, semiconductors, software, and other tech products. Imposing tariffs on these would hurt China's own industries more than the U.S., as these products are hard to source elsewhere.
Energy and Agriculture: Commodities like energy and grain are essential imports for China, and imposing tariffs would reduce supply options, leading to higher prices from alternative suppliers. This, again, would punish China more than its trading partners.
Limited Diversification: Unlike consumer goods such as clothing and footwear—where suppliers are abundant—energy and agricultural commodities have a smaller pool of competitors.
Forced Currency Devaluation
With limited retaliatory options, Beijing would likely turn to currency devaluation as a countermeasure. But this approach comes with its own risks, including capital flight, inflationary pressures, and eroded purchasing power for Chinese consumers. A significant devaluation could destabilize the financial system, further compounding existing domestic challenges.
The Broader Implications
This layered crisis underscores the fragility of China's economic model under external and internal pressures. Investors should carefully weigh the risks associated with geopolitical tensions and economic policy constraints, as these factors could significantly impact the prospects of even fundamentally strong companies in the Chinese market.
In the words of a popular Chinese saying, “The raging waves are inevitable.” The question is not if China will feel the heat of this economic storm, but rather how prepared it is to navigate it.
Why Could the Yuan Break 10 to the Dollar?
The notion of the yuan depreciating to 10 against the dollar may seem far-fetched to many. After all, isn't the U.S. market just a small part of China's total exports? Why would such a significant devaluation be necessary?
Let’s break it down step by step, using historical data and a closer look at the underlying factors.
Historical Context: Lessons from the First Trade War
During the first phase of the U.S.-China trade war (2018–2019), the U.S. imposed a 25% tariff on $200 billion worth of Chinese goods. At the time, China's total exports to the U.S. in 2019 were $418.5 billion, out of a global total of $2.6 trillion—making U.S.-bound exports about 16% of China's total. Yet the yuan still depreciated by 10% during this period to offset the impact of the tariffs.
Fast forward to 2023: China's exports to the U.S. reached approximately $500 billion. If tariffs were raised to 60% across the board, the yuan would likely need to depreciate by around 50% to maintain competitiveness. While this figure might sound exaggerated, it aligns with past trends and the scale of economic adjustments required.
Misconception: The Real Weight of U.S.-Bound Exports
One common misunderstanding is that U.S.-bound exports only account for a small portion of China’s overall trade, so their impact on the yuan should be limited. However, this overlooks several critical factors:
Indirect Exports via Third Countries:
A significant portion of Chinese goods destined for the U.S. are first exported to intermediary nations like Hong Kong, Vietnam, or Mexico before being re-exported to the U.S. as "local" products. For instance, while official data suggests U.S.-bound exports make up about 16% of China's total exports, the actual figure—including indirect exports—is likely closer to 25–30%.
These indirect flows often involve minimal changes, such as relabeling or light assembly, before the products reach the U.S. market. Recognizing this, the U.S. government has recently intensified its scrutiny of product origin to close such tariff loopholes.
Trade Confidence and Exchange Rate Dynamics:
The U.S. remains China’s largest single-country trading partner, serving as a key benchmark for market confidence in the yuan. If U.S.-China trade falters, it shakes investor trust in the stability of yuan-denominated assets. This lack of confidence exerts downward pressure on the currency beyond the immediate trade impact.
Geopolitical Tensions and Broader Risks:
A 60% tariff rate would not just be about trade—it signals an escalation in geopolitical tensions, including political, military, and diplomatic standoffs. Such an environment heightens perceived risks, prompting investors to reduce their yuan holdings, further weakening demand for the currency on the international stage.
The Bigger Picture: More Than Just Tariffs
The link between tariffs and yuan devaluation isn’t purely mechanical. The ripple effects extend beyond trade to touch on confidence, investor behavior, and geopolitical uncertainty. A substantial depreciation of the yuan might be unavoidable—it’s just a question of how fast and how far it will fall.
In this context, the scenario of the yuan breaking 10 against the dollar no longer seems implausible. It reflects not only the direct economic adjustments required but also the broader shifts in global dynamics and investor sentiment. I maintain sell on China Stocks.
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