The value-investing argument of the ages is playing out over whether China’s tech crackdown is a reason to cut ties with the mainland or a necessary risk worth taking.
On the “sell China” side are two household names from different generations: George Soros and Cathie Wood. Soros, of course, is synonymous with the 1990s. His short-selling exploits brought the UK economy to its knees early in that decade and then made Malaysia’s 1997-98 period a living hell.
Cathie Wood is Wall Street’s most-followed guru at the moment. Her flagship ARK Innovation exchange-traded fund, like the investment firm that bears the Soros name, is dumping its China exposure.
Both are expressing concern about President Xi Jinping’s crackdown on tech triggering trillion-dollar market losses. And general confusion over Xi’s sudden drive for what his government calls “common prosperity.”
Or are Ray Dalio of Bridgewater Associates and HSBC Holdings Chairman Mark Tucker right to take the other side of the “avoid China” trade?
Dalio, who runs the world’s largest hedge fund, argues China’s promise trumps today’s regulatory chaos. As he put it recently: “The American and Chinese systems and markets both have opportunities and risks and are likely to compete with each other and diversify each other. Hence, they both should be considered as important parts of one’s portfolio. Look at the trends and not misunderstand and over-focus on the wiggles.”
This week, HSBC’s Tucker was in Hong Kong arguing that investment opportunities in Xi’s China are “too big to ignore” despite the geopolitical tensions clouding Asia’s outlook.
“We’re moving to a new status quo in Sino-US relations,” Tucker said at a Hong Kong Academy of Finance event. “The interconnectivity is pretty powerful, and I don’t think it will get to a point where sides will need to be chosen.”
Who’s right? As with most investment theses, the truth can probably be found somewhere in between. But the real question that matters is whether Xi’s inner circle uses the opportunity that this debate affords Beijing.
As economist Stephen Roach, formerly with Morgan Stanley, explains: “Even if US companies don’t trade directly with China, virtually everything they touch goes through global supply chains. So, a chill in the US-China relationship has significant implications for US companies and for investors investing in US companies. You can’t get away from the China connection.”
In other words, an “ex-China” strategy is more aspiration for investors than a workable approach to today’s global economy. Xi could read this as a license to throw China’s weight around and show investors who’s boss. A better approach would be to take the initiative to explain to an anxious world what Beijing is really up to in policing Ant Group, Didi Global, Tencent Holdings, private educators and heaven knows who’s next.
By spelling out the what, why and who of this new model Beijing appears to be crafting on the fly could buttress the Dalio-Tucker arguments for tolerance.
The trouble is, the confusion factor is making the Soros-Wood trade an increasingly crowded one.
A recent survey by Bank of America Corp suggests it could get even more congested if Beijing doesn’t tamp down on the regulatory uncertainty. Paul Marshall at the US$59 billion investment firm Marshall Wace said that given Beijing’s recent moves, “you could argue that US-listed Chinese American Depositary Receipts are now uninvestable.”
In the first half of 2021, the MSCI China Index surged to a 27-year high as investors, teeing off talk of a “V-shaped” recovery from Covid-19, rushed China’s way. Now, capital is zooming the other way. Earlier this week, the MSCI China Index plumbed its lowest levels versus the S&P 500 since 2005. Jack Ma’s Alibaba Group just fell to a record low.
Part of the uncertainty is on the US side. Since January, US President Joe Biden has refused to scrap Donald Trump-era China tariffs.
This week, Gary Gensler, Biden’s Securities and Exchange Commission head, directed his staff to take “a pause for now” in approving initial public offerings of Chinese firms considered shell companies. Gensler is warning investors to watch their backs investing in mainland companies.
Another element of uncertainty is confusion about whether Xi’s China is turning its back on capitalism.
Xi’s talk of “common prosperity” has global investors in a bit of whirl. Here, the not-so-cryptic “spiritual opium” Mao Zedong allusion by regulators going after Tencent hardly helps.
One possibility, says analyst Andrew Batson at Gavekal Research, is that Xi’s call to “encourage high-income groups and companies to give back more to society,” aka “tertiary redistribution, is going to usher in the next stage of what I’ve been calling corporate social responsibility, with Chinese characteristics.”
There is an argument, in other words, that just as Xi is hoping to avoid a future in which local equivalents of Amazon, Facebook and Google dominate China, he’s also looking to head off the extreme income disparities of, say, Hong Kong.
Yet Xi must mind the gap between investors’ expectations over the next year with where he hopes to guide China a decade from now.
An intensifying capital flight would serve no one, least of all China’s standing as a trusted investment destination. Since 2016, few priorities have topped Xi’s list like internationalizing its financial system, starting with the yuan.
The first step was getting the yuan included in the International Monetary Fund’s “special drawing rights” basket, putting Beijing closer to rivaling the US dollar.
In the years since, increasing and broadening the channels for foreign investors to access stock and bond markets. That includes mainland shares being added to the MSCI index and government bonds to the FTSE Russell. And harnessing the fact that China, by some measures, now has more billionaires than the US.
Guo Shuqing, head of the China Banking and Insurance Regulatory Commission, rarely misses a chance to say that the rate at which national savings increases are “often closely tied to its financial power.” In recent months, Guo has been reassuring investors that China remains determined to continue easing barriers to foreign investment.
Yet recent events on that score aren’t reassuring. This week, Taiwan Semiconductor Manufacturing Company, or TSMC, surpassed Tencent in market capitalization thanks largely to fallout from Xi’s tech crackdown.
Xi’s seemingly scattershot approach to hitting some of the economy’s most vibrant sectors is repelling some of the foreign investors China claims to be welcoming. This has investors doing their best essentially to read the tea leaves.
The only thing investors know for sure, says analyst Lauren Gloudeman at Eurasia Group, is that “priorities for regulators will include antitrust, data and national security, social equity, consumer protection, financial risks, and managing vulnerability to foreign regulations; this reaffirms that e-commerce platforms and tech companies with disruptive business models will remain under the highest scrutiny, though online education will remain an outlier in the severity of its actions.”
Gloudeman adds that while investors have begun “rotating into sectors that are strategic priorities for Beijing – particularly hard tech and advanced manufacturing – this also comes with risks; regulators will act if they fear speculative pressures threaten financial stability or market discipline.”
So far, though, it’s Xi’s regulators doing the most to threaten financial stability. That has some investors feeling threatened and looking for exits and others strapping in for a ride they see as worth taking. Xi’s team needs to make China Inc less of a wild ride. There’s no time like the present to narrow these extremes.