Chinese equities just had their strongest week in years
KWEB, an ETF tracking China’s tech sector, recently celebrated ten years of trading with a lost decade.
Companies like Alibaba traded down to ~7x PEs, even after buying back 2% of their shares a quarter. Only a few years ago Chinese tech was competing with Silicon Valley for dynamism.
What a difference policy can make.
Jack Ma’s disappearance, the cancellation of the IPO of Alibaba’s subsidiary Ant Financial, and the immediate retirement of the visionary founders plunged the sector into an icy winter.
And the big end of town got off relatively lightly. Smaller companies were completely wiped. Anyone remember the crackdown on tutoring?
TAL – a Chinese tutoring company
(For what it’s worth our risk model would have performed quite well in these situations):
Internet, e-commerce and social media companies were seen as distractions at best from the serious business of manufacturing and defence.
But social media companies and the like are politically problematic – as most in the West would agree – and their founder CEOs amassed considerable power and influence.
It was made quickly clear that no person or company should shine too brightly.
Several times since officials floated market friendly talk, only for a renewed crackdown to knock the stuffing out of any market recovery.
To give a recent example, Pinduoduo just announced an excellent result, posting revenue growth of 86% year-on-year, and net income growth of 144%, all with significant net cash and a single digit PE.
But the press release had CCP-coded rhetoric throughout, causing a rapid 40% sell-off.
‘Investing heavily’, ‘short term sacrifices’, a ‘decline in profitability’, and ominous ‘tackling’ of low quality merchants: this is a firm apologising for its success and trying to dull its star:
It was not just politically challenging social media and e-commerce that came under attack. Gaming was frowned upon, as seen in the periodic crackdowns on Tencent’s ecosystem, and the entire VC industry collapsed.
It didn’t help that this coincided with some of the most wasteful VC spending of all time, which is saying something. Mountains of busted bikes and destructive ridesharing subsidies are the most obvious examples.
A field of abandoned bicycles. These three images come from this article.
The crackdown was paired with renewed focus on heavy industry, manufacturing, and defence. Chinese-built phones and cars began to quickly replace iPhones and Teslas in the politically conscious and ambitious.
But this came at a cost – the destruction of the dynamism in one of the few places that could feasibly challenge the United States.
Most of the above could have been written at any time in the last two years. So what’s changed now?
In May this year Xi Jinping asked, ‘where are all the unicorns?’.
As of this September 2024, only $26 billion has been raised by Chinese startups, down 82% from 2021. And most of this was from state-run VCs, with foreign investors almost completely absent.
I can’t help but wonder if this time the recovery might be real. It certainly feels like there’s more weight to the move.
And there is something very different this time: the same companies that were the target of the crackdown are now at the center of the most revolutionary advance in computing since the internet.
In the United States thousands of entrepreneurs are throwing their hats into the startup ring to take advantage of these new capabilities, right as China’s startup scene remains a fraction of what it once was.
And it’s not just startups.
Language models are a game of scale. There is only one company with the size to manufacture the most advanced GPUs, and only a handful of companies that can afford to build hundred billion dollar clusters – and they are all in the United States.
After a stonking rally last week, Alibaba’s market cap is still only $230 billion, with Tencent at $500 billion. These companies will not be investing a trillion dollars in GPUs any time soon.
And it’s not just the startups, or large tech companies where the United States is winning. The leadership has been extraordinary.
Under sometimes fierce criticism, Zuck sunk tens of billions annually into GPUs and datacenters. Larry Page is back at Google and Elon Musk has come from behind to build one of the leading clusters under xAI. Satya Nadella at Microsoft made early, aggressive moves to control the trajectory of OpenAI.
Imagine if Jack Ma and the other leaders were still in full command of their companies.
Stimulus
Someone must have got the message, as a series of stimulus announcements last week lit a fire under the market.
It was the best week for Chinese tech stocks in four years.
The support package is the largest since the pandemic.
Rates were cut by 50 basis points,
A package of $2 trillion over two years is on the table, representing 4% of China’s GDP,
And China will lower borrowing costs on mortgages and reduce the minimum downpayment on second homes from 25% to 15%, all to support the housing sector.
And most importantly for our industry the stock market itself is getting special support.
Securities firms will gain access to over US$200 billion in swap facilities to purchase equities,
An additional US$128 billion will be made available for listed companies to buy back shares worth US$128 billion,
And a state stabilisation fund is being discussed.
Chinese stocks are now as overbought as ever, but on a longer term view they are just coming off an extremely low base.
Another false dawn for Alibaba? Or is this the start of a major rally, like 2016
A negative ten year return is rare, I remember in 2009 and 2010 when US equities had the same bleak statistic – which is =almost unimaginable now. That marked the beginning of an astonishing decade.
In line with other major lows, this chart from @macrocharts shows there is a significant short position that might now be trapped:
My guess is as good as anyone’s, but with the most serious stimulus so far, an urgent need for powerful tech companies, and seriously depressed valuations after a multi year bear market and a lost decade, it will be interesting to see if this time the turn-around is real.
