China’s small investors have this advantage over some of world’s most powerful money managers
Some 15 years ago, a survey of retail stock investors in China showed that nine out of 10 polled vowed to never put a put a dime in the markets again. Scandals were rife, earnings pitiful and many investors were angry at the clown-quality of companies listed on the domestic bourses.
In those days, foreign investors tended to get the best deals, such as being exclusively sold stakes in some of China’s best franchises like the duopoly in telecommunications, which provided monopoly-like returns in the late 1990s.
Another example is the run-up in China-based export stocks in the early 2000s, in line with the country’s fast-expanding trade surplus. Many of these exporters were non-Chinese companies like toolmaker Techtronic Industries, operating in China but listed overseas. Only those mainland Chinese investors who illegally opened up overseas trading accounts were able to get a slice of this action.
These days, however, trading conditions favour domestic investors, if haphazardly so. In an environment where credit creation remains robust but many sectors are officially or administratively closed off from new investment, the challenge is figuring out “where will the money go next?” It is a high risk, dangerous game, but Chinese investors are still up to the challenge, despite getting burnt in last year’s market crash.
Take the pop in commodities earlier this year. Unlike in the West, where professional investors do most direct commodities trade, in China retail investors can load up on metals, materials or agricultural goods with a few clicks on their smartphones.
There are still select cases of fantastic, monopoly-like profits. “A ‘Beat and Raise’ Quarter (Again)” is how Daiwa Securities titled its report last week on Tencent’s first-quarter earnings, which exceeded consensus expectations by 5 per cent as revenues jumped 43 per cent year on year in the first quarter and net profit rose 39 per cent. But such opportunities are dwindling, and foreign investors are worried about macroeconomic risks and high corporate leverage levels.
“We believe global investors are overly concerned about China’s credit blow-up risk,” Citi Research wrote in a note to clients last week, noting that unlike the overall economy, publicly listed companies have been deleveraging. Based on a screening of 2,800 A shares, Citi found that aggregate net gearing dropped 6 percentage points to 39 per cent as of the first quarter of 2016 as companies have shored up equity positions and cash holdings.
Then there is a risk of decline in the yuan, one that has less of an effect on domestic investors than international money managers.
When banks or brokers ask their mainland clients to gauge market sentiment, the answers they get are often related to policy: their expectations on what stocks the “national team” is likely to snap up or sell, or where the next infusion of central bank liquidity will splash down. Obviously trading is much reduced since before last summer’s crash, but securities investment activity in China is far from dead. It is just that the best opportunities are transitory.
Short-term wealth management products available in the shadow banking market, for example, have offered envious returns and seem to carry an implicit state backing. So far there have been few defaults on these fixed-income vehicles, and many of the profits ultimately derive from arbitrage between cheap money provided by the central bank and higher-yielding short-term bills.
Credit conditions remain loose in China even as policymakers are trying to implement reforms to improve economic efficiency – that is, to lower the dependency on cheap money and splashy infrastructure investments. Thus the State Council this month proposed to cut steel and coal capacity of central state-owned enterprises under the aegis of “supply side reforms”. In the same spirit, Sichuan province announced on May 2 that it would set up a 2 billion yuan fund to provide financial subsidies to enterprises that voluntarily agree to reduce capacity.
So in an environment where liquidity is generous but many sectors are prohibited from borrowing or expanding, money sloshes between asset classes and gains are often derived from anticipating policy decisions or front-running liquidity injections. These conditions are far from ideal, but interestingly they favour mom-and-pop investors in China over some of the world’s most powerful and sophisticated money managers.
Cathy Holcombe is a Hong Kong-based financial writer