CNBC Power Lunch 7/12/22

Is China Investible?

Summary: Is China investible? NO it is not. (For the reasons, see below.) On Tuesday, Jonathan Brodsky and I had a the chance to talk with Tyler and Kelly on CNBC Power Lunch about investing in China. Jonathan made the bull case; I was the bear. My bottom line is th stay away from all Chinese investments at least until October, when Xi Jinping expects to be ‘elected’ to his third term as President. After that, I will still not not think it is safe to invest in a country with one-man rule and no rule of law. You can see a short video of the spot below and read the talking points I prepared for the producers before the show.

Talking Points for the show: As I have explained before, before every show I send talking points to the producers so they can brief the anchors on my main points. I have copied them here for you just as I sent them to the producers, typos and incomplete sentences intact, so you can see how we work. In this case it was easy. because I have worked with Kelly Evans, Melissa Lee, and Tyler Mathisen dozens of times and they are all very smart. Enjoy.

Here are a few talking points.  My overall view is that this is a huge week (Hell week?) for China news (COVID BA.5, lockdowns, GDP, trade, PBOC, fiscal stimulus). Not good news. Growing pressure on Xi Jinping ahead of his bid October event is making him erratic. New policy “New Development Concept” is a hard return to central planning. Criticized some service company (tech) CEOs as unpatriotic, denied funding, said they are all in “partnership with the state”. In system theory this is known as the “Savonarola Effect”—a system, when attacked by a pathogen, retreats backwards along the same path it took to reach its current position. If you look backwards in China you will see the smiling face of Chairman Mao. Not good.

Huge week coming up for China date. It won’t be pretty. Xi Jinping can kiss his 5.5% GDP growth target goodbye. Here are a few reasons.

1. COVID will continue to be a drag on the Chinese economy.

   1. There were 2300 locally-transmitted cases last week. Shanghai had 69 cases Sunday (most since May)

   2. the BA.5 variant is alive and well in China now.

   3. 1st local cast last Tuesday in Xi’an. Locked down. 13M people

   4. 3 cases in Beijing same day

   5. 1st case in Shanghai reported

   6. 31 cities with restrictions yesterday (11 a week ago)

   7. 11 cities locked down, 114M people, 15% of economy.

   8. Macau locked down for a week. 

   9. Look for more supply chain disruptions in the coming weeks

   10. Takeaway: these numbers are tiny for rest of world, but not for China due to Xi’s Zero COVID policy. He has staked his reputation on Zero COVID. He refused western mRNA vaccines when they became available. This is his baby.

2. GDP #s this Friday

   1. Q2 GDP will LIKELY be 1.2% YOY but -2% QOQ. Only negative number EVER except for the Q1/20 Wuhan air pocket quarter.

   2. 5.5% target? “fuggediboudit". the full year will be more like 4%.

   3. local officials under pressure to goose numbers to help make the target but not much they can do.

   4. 2 month Shanghai lockdown took 2022 GDP from 8.4% to 4.1%. There will be more lockdowns in the second half.

   5. weak autos, esp commercial buyers. Weak apartment sales.

3. The government is throwing all the stimulus measures they can at the problem.

   1. accelerate $200B municipal bond sales to H2; originally scheduled for 2023.

   2. $75B infrastructure fund announced for Q3

   3. car tax cut last mo. 

   4. PBOC Liquidity measures. 800B new credit. M2 growth 11.4%. Likely cut in lending rate this Friday

4. Trade numbers out Wednesday

   1. watch for weak commodity imports for signals of continuing low demand for copper, iron ore, aluminum, oil, food prices.

5. Unrest.

   1. Zhengzhou, Henan riot on Sunday to protest frozen bank accounts from April bank shutdowns. Allegations that local officials abused the COVID health-warning app to force demonstrators into quarantine.

   2. Demonstration crushed by thugs hired by local government officials. 5 Govt officials arrested. Triggered announcement that depositors will start to receive some cash this Friday.

   3. There is deep resentment following the 2 month Shanghai lockdown.

Xi Jinping under pressure. 

1. Xi Jinping announced his New Development Concept, effectively pushing China back in the direction of central planning

2. Singled out CEOs, criticized their patriotism

3. Said all companies are in “Partnership with the state”

4. 3 service cos denied funding because they were not ‘priorities’ for the government. Capital will be allocated directly from Beijing

5. Kevin Rudd, former Australian prime Minister with deep China experienced referred to the new direction as “Pivot to the state"

6. I call it the Savonarola Effect. When a complex adaptive system, like the Chinese economy, experiences a major shock, it retreats backwards along the same path it previously followed. In China that means back to government control.

Conclusion for investors: there is no safe way to deploy capital in a situation where one man can pick up the phone and completely undermine the fundamentals of a business. Stay away until things change.

Dr. John