Investment Letter from Hong Kong March 2017

The stimulating free port of Hong Kong remains a compelling eye glass through which to comprehend China, its politics and economy. All its 5.5 million adult inhabitants are China watchers, by inclination or necessity. Their world view was formed, to some extent, by the Cultural Revolution. The most recent arrivals in Hong Kong are investors from China and increasing numbers of economic migrants from Europe, most notably France. The latter’s response to the despoir of home is to find hope in Hong Kong. “Try Hong Kong” they used to say, not always in kindness.

Like London, Hong Kong operates as a safe-haven from volatile regimes: a portal through which Chinese capital passes, sufficiently easily to slay the notion that China’s capital account has effectively closed.

Somewhere in the past two years – and its is difficult to say precisely when – the authorities in Beijing ceded their former near total authority on its currency policy with respect to the renminbi (RMB).

The secondary effects of running so much capital through a thin spigot into Hong Kong are increasingly bad for the bulk of the population. Property prices there are debilitating to those without established ownership, small businesses struggle and young people feel alienated. These factors have prompted a response. Hong Kong, for all its libertarian fire, is also a place where spectacular interventions sometimes happen. The fact that 30% stamp duty has not yet stemmed inward flow into property is testament to the power of forces driving it: capital flight does not have to be underpinned by any discernible investment value.

Strangely for Hong Kong, the best economic outcome, at least for the longer run, would be the bursting of the property bubble which has been inflated by flight capital. It would reduce the burden on businesses and perhaps mitigate the alienation felt by younger people. This could happen either by China closing the portal on its wealthy or by the strangle of higher US interest rates.

Turning to China qua China, last year’s upswing found its rationale in the current political cycle which is on the cusp of its five-yearly renewal. The National People’s Congress has just sat and presages autumn’s National Congress of the CPC.

Through its reflationary efforts, China was the progenitor of last year’s recovery in deep cyclicals in global markets. Its own metal bashers have been placed on advisement that they will be rationalised via mergers and capacity cuts. It is hard to see how capacity could rise – the consumption of materials – steel, cement and others – in the last several years has been prodigious.

Robin Parbrook and his team at Schroders Asia have identified what they term 3Ds: demographics, deleveraging and dematerialisation which will conspire to reduce potential growth in the Asian region and whose combined effects are most pernicious in China. The first two concepts are well enough known, the third describes a world in which physical materials become a proportionately smaller part of the economic system. It was Alan Greenspan who pointed out that whilst the value of economic output has quadrupled in the past 50 years, the physical weight of it has barely budged.

Most international investors are justly shy of investing in State Owned Enterprises and ginger toward Chinese banks whose balance sheets they mirror and are therefore shoehorned into consumer plays and the info tech players.

Technology has proven to be the better place to be: the sector constructed as a type of walled garden seeded by a Google, Amazon and Facebook whose simulacra exist in the shape of Baidu, Alibaba and Tencent: none of these US firms operate in China in their own guise.

Fay Ren has written a good summary about what these home-grown companies are up to and how they are augmenting.

https://cernocapital.com/china-tech-cubs-pandas/

State supervision is so encompassing that most Chinese assume that all their communications are routinely surveyed, removing that anxiety of “am I being watched or not?” The phenomenon of relinquishing anxiety over state censorship because it is a given is thought, by some, to be liberating, however perturbing that sounds.

This unremitting state censorship of the new media has spawned great opportunities for those who have absorbed what the kids in California have done and translated it into the China context.

Mishaps have taken place. Fake search ads promising miracle cures became a national concern last year. On the other hand, some of the technologies have been taken further in China, as the astonishing suite of WeChat products testify. There is no secret to what China is looking to do: suck in technological know how, apply capital and seek to dominate.

The Financial Times recently reported details of China’s Thousand Talents programme under which is has been recruiting Tech talent from the West: “On top of a Rmb1mn (US$144,000) welcome package, there are guaranteed school places for children and job offers for spouses”.

The plan to dominate has now been published under the state’s Made in China 2025 plan: a call to arms that could have very distinct consequences in a few years. The plan calls for the creation of a national Chinese manufacturing superpower by harnessing technology. Its avowed target is to replace foreign made imports of physically manufactured goods, from the semiconductor up.

Berlin based Mercator Institute for China Studies (merics) who study these matters on behalf of tremulous Western multinationals has issued an advice paper on the subject. It implores its constituents to, for example: “act with caution regarding R&D activities in China, prevent unidirectional technology transfer and to avoid illusions about the technology gap”. Their SWOT analysis lingers on the Ts.

The Cerno Pacific & Emerging portfolio looks to access long term themes in Asia Pacific and the wider Emerging Markets. If you would like to learn more about this, please email Olivia Martin ([email protected]).

James Spence
Managing Partner

In Hong Kong, James met with the macro strategist Simon Ogus, editor of Week in China Steve Irvine, recently retired Hong Kong Monetary Authority official Peter Pang, Manish Bhatia, Rebeca Xu and Ying Ying Wang of Schroder’s Asia, Jeff Kung of Frontier Asia, Catherine Yeung of Fidelity, Federico Bazzoni of CITIC Securities, Greg Penn of CBRE, Alex Jenkins of Cathay Pacific Airways, Neil Scrase of City Financial, independent property sector specialist Reynold Chan and Paul Krake, Cindy Ponder and Rupert Mitchell from the independent research service View From the Peak. He also spent time with his many in-laws. The views within this letter should be ascribed to the author and not to the above-named persons.

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By |2017-03-26T14:12:54+00:00March 26th, 2017|Investment Letters|

About the Author:

James is a co-founder of Cerno Capital and lead manages a number of the firm’s collective and private portfolios. After qualifying as a chartered accountant in London (Coopers & Lybrand, 1989) he relocated to Asia. Between 1991 and 2004 he worked as an equity analyst, head of research, and latterly as an equity strategist at WI Carr, Paribas, HSBC and UBS, based variously in Hong Kong, Singapore and Jakarta. James graduated from the University of St Andrews, Scotland with an MA in Philosophy & Logic in 1986. James is a Member of the Chartered Institute for Securities & Investment.