In an earlier blog, Brandon shared his thoughts on the underlying sources of growth in the Chinese economy and the significant role easy credit has played in sustaining economic growth and funding distressed industries. The natural question then is: why would hard-working savers put all of their money into risky investments with uncertain returns or in a bank that makes risky loans?
In a market with suffocating capital controls1, taking advantage of international opportunities is not an option for most savers and investment opportunities need to be close to home. This key restriction funnels the collective wealth of the Chinese savers into a few speculative areas – both directly and indirectly allowing local governments to borrow at very low rates to fund high-risk companies. In short, the Chinese savings market has played a critical role in warping capital allocation decisions and it has led to speculative asset bubbles in the domestic economy.
During our previous trip to China last June it was clear that the property market was on an unsustainable path as builders took advantage of cheap financing from savers to build high-risk projects on a grand scale. This was compounded by speculative buyers entering the market and purchasing multiple homes to bet on higher prices. One of the most striking examples we saw was a senior executive of a mining equipment manufacturer talking at length about the many homes he purchased while, at the same time, not owning a single share of the company at which he is employed.
Over the past year, as the property market has continued to cool, the excitement has moved into the equity market which also has strict limitations on ownership to domestic Chinese stocks only. There have been more new trading accounts opened in the last four months of 2015 than the last four years (2011-2014) combined which has fuelled a surge in the market that has lifted all boats.
We wanted to share some of the most striking examples of the excesses we have observed:
- China National Nuclear Power: “China’s initial public offerings are such hot commodities that a company seeking $2 billion attracted bids approaching the entire annual economic output of Hong Kong. China National Nuclear Power Co., the country’s second-biggest atomic power operator, locked up 1.69 trillion yuan ($273 billion) in bids for its IPO.” —Bloomberg
- Cloud Live Technology: “Cloud Live Technology Group Co. said it was short 240.6 million yuan ($39.2 million) needed to pay back 400 million yuan in debt it sold three years ago. Until last year, Cloud Live was known as Beijing Xiangeqing Group Co. Under the English slogan “Delicious Food,” it ran 18 restaurants specializing in fiery fare from China’s Hunan province. In May 2014, the company that became Cloud Live said it would raise 3.6 billion yuan to fund an expansion into big data and cloud computing.” —Wall Street Journal
- Goldin Financial: “Attention has shifted to steep falls in Goldin Financial, a broker that provides short-term corporate financing. That stock fell 43% Thursday, wiping out $12 billion of market value. A smaller property developer with the same top shareholder, Goldin Properties, fell by 41%, reducing its market capitalization by $4.6 billion.” —Wall Street Journal
- Expensive stocks purchased on credit: “ChiNext, is a board for start-ups, especially tech firms, its price-to-earnings ratio has reached 130x. ChiNext is supposed to be China’s answer to Nasdaq. The outstanding volume for share financing has more than doubled over the past year to more than 2 trillion yuan, or about 3% of GDP.” —The Economist
- Unsophisticated investors: “China Household Finance Survey which surveyed 4,000 households in late 2014 and found a majority of the new investors in China’s market don’t have a high school education (6% are illiterate).” —Fortune
The stories are remarkable but it is the structure of the Chinese savings market that needs to be changed to rebalance the economy. We continue to monitor the developments in China for continued signs of stress while sticking to our knitting and remaining focused on finding high-quality businesses with well-aligned management teams.
1China limits local residents from withdrawing more than $50,000 USD out of the country annually and can only withdraw $2000 per day while also requiring approval from The State Administration of Foreign Exchange (“SAFE”). This means taking money out of China officially is a bureaucratic and difficult process.