There's one US$18 trillion question facing globally inclined investors these days: Can you buy Hong Kong and Chinese stocks and still sleep at night?
The short answer is, yes, more than likely, with a major proviso. As you'd expect from such a big-ticket query, there are several factors to consider. It has been a question that markets have struggled with mightily in the last few days of trading.
Hong Kong has a partial answer with an end to its never-ending semi COVID lockdown. We're finally about to be free, or so we're told. That will restore a little of the luster lost from the city's gleam, though it is no longer the first place to base yourself or your company if you're looking to work in Asia.
The world's harshest quarantine will end April 1, with a flight ban removed on nine nations, including the United States. Hong Kong residents have not been allowed to return to the city from U.S. visits or from Australia, Canada, France, India, Nepal, Pakistan, the Philippines and the United Kingdom. Such a suspension is "no longer timely," our supremely unpopular supreme leader Carrie Lam finally concedes, because the COVID situation in those nations is often "no worse than Hong Kong." Schools, gyms, beaches and bars will reopen in phases from April 19, according to the plans released today.
What was a 21-day enforced stay in an extortionately expensive Hong Kong hotel will now be cut to seven days for most travelers. All the testing and hotel stays and close-confines imprisonment were straining family budgets and familial relations. I figured the COVID costs for my family of four were adding around US$8,000 to any step out of this territory, where I've been locked in a space smaller than the cities of Phoenix or Nashville for two years and 74 days. But who's counting! I went into more detail with in column Trapped in Hong Kong by Zero-COVID.
We're all counting the cost. The zero-COVID strategy deployed in mainland China and Hong Kong has been a major drag on growth prospects. The Beijing government still persists in the "ZCS" approach, to its detriment. But it no longer makes sense here, with more than 1 million out of 7.4 million Hong Kongers already infected, by the official count, and 3.6 million or half the population infected according to modeling by Hong Kong University's epidemiologists.
Hong Kong stocks have yet to reflect this new reality. It's darkest before the dawn and all that, but it has taken a really bad outbreak of COVID-19, one in which Hong Kong has led the world in per-capita death count, to ram the message home: We're going to have to learn to live with this disease.
Hong Kong stocks moved down again here on Monday, with the Hang Seng down 0.9%, while the CSI 300 of mainland stocks was little-changed, down 0.2%. But those changes are prosaic when we've had stocks the likes of Alibaba Group Holding ( (BABA) and HK:9988) bouncing around by 45% between the close last Tuesday and last Thursday. China's largest e-commerce site edged 0.8% ahead today.
The answer to the US$18 trillion question will require mainland China to work its way out of ZCS, too. The Chinese economy stands at US$18.4 trillion this year, according to Statista, and there are substantial risks that will make it hard to function at anything close to full capacity or to hit the official growth target of 5.5%, particularly if the central government makes good on its promise from Friday to catch local government officials who concoct GDP data because their jobs and their salaries depend on it.
Talk about inflation. The old radio game show Take It or Leave It originally posed its participants a US$64 question. Get it right and they'd win that amount. The sum was raised significantly, of course, by Who Wants to Be a Millionaire in the 1990s. Dr. Evil realized US$1 million wasn't nearly enough; his ransom was US$100 billion after a little adjustment.
Chinese stocks have a market capitalization of US$12.2 trillion, according to the last count by the World Bank, second only to the US$40.7 trillion in the United States. Add Hong Kong and its US$6.1 trillion market cap, fourth behind the US$6.7 trillion in Japan, and you also have an US$18.3 trillion value for greater Chinese stocks.
Nomura talks to itself
Nomura is also asking itself The China questions in a report by that name that it sent to clients today. The investment bank's Asia ex-Japan strategists are battling to make sense of "extraordinary movements" in Chinese stocks, conceding that recent weakness is one reason "many investors appear to be giving up on China."
Hong Kong stocks were the world's worst performers last year, as I explained entering this year, with the Hang Seng surrendering 14.1% of its value. Hong Kong stocks are still down 8.8% despite a 15.2% rally in the last week.
Mainland Chinese stocks also lost ground last year, with the CSI 300 off 5.3%, and they are still suffering to the tune of 13.4% year to date in 2022. Like Hong Kong, that's even after they have climbed 7.3% since mid-morning last Wednesday.
Nomura concedes its positive call on Chinese equities over the course of the last two years "has not worked." Brutal, but honest. It looks at a lot of fundamentals, which show China stocks should be attractive, with the MSCI China trading at a 12-month prospective price-to-earnings (P/E) ratio of 9.7, much cheaper than the P/E ratio of 21 on Indian equities. U.S., U.K. and Japanese equities all promise single-digit earnings growth at double-digit P/E multiples, while Chinese earnings look set to rise at a compound annual rate of 14.6% through 2023.
But the real reason there has been both forced and voluntary selling in Hong Kong and Chinese names is that no one can predict what move Chinese regulators will make next. They have taken many, many market-moving steps -- you could call it a Great March -- in a destabilizing pattern that robbed investors of confidence.
Then there's the tension between the U.S. Securities and Exchange Commission and its equivalent, the China Securities Regulatory Commission. Their push-pull over accounting standards and whether the SEC can access currently off-limits Chinese auditing threatens to force the delisting of at last count 248 U.S.-listed Chinese stocks with a market cap of US$2.1 trillion.
These are the real US$18 trillion question marks that must be removed. Nomura notes that the Chinese government is itself a big investor in Chinese stocks, because it is part-owner of many state-owned enterprises. The top 20 Chinese banks alone paid the Chinese government US$40 billion in dividends last year. China Mobile HK:0941, a US$140 billion company by market value, paid US$6.4 billion in dividends to the government, which owns 70%.
But far fewer folks care about sectors such as Chinese financials anymore. Banks and telecoms used to make up more than half the Chinese stock index a decade ago, a tally that is just 11% today, Nomura notes.
It's all about tech
We care more about Alibaba, Tencent Holdings ( (TCTZF) and HK:0700), Meituan (MPNGY and HK:3690), JD.com ( (JD) and HK:9618), Baidu ( (BIDU) and HK:9888) and NetEase ( (NTES) and HK:9999). Those six companies alone make up more than 30% of the MSCI China world.
"We also believe that the Chinese government wants these companies to be successful," the Nomura analysts say, less convincingly. Success for Big Tech in the eyes of lawmakers, be they the Chinese Communist Party or the U.S. Senate, may look different than it does to tech-stock investors.
The harsh treatment of Chinese Big Tech in the last 18 months has been partially warranted in a bid to break up monopolistic behavior, but partially appeared to be an attack on privately-held, non-state-owned enterprise. Chinese President Xi Jinping's clarion cry of "common prosperity" transitioned into an attack on rich entrepreneurs.
"We believe there are too many watchdogs looking at the China Internet space," Nomura writes, and I agree. Consider the very harsh treatment of Didi Global DIDI after it listed on Wall Street. The company had clearly satisfied the requirements of Chinese stock regulators, using the age-old approach the other 247 New York-listed Chinese companies had used in going public. All of a sudden, a cybersecurity review sprang to prominence for the first time, never a requirement, but now a secret additional set of criteria that a Chinese company had to satisfy.
It's of little consolation to DIDI investors, still nursing disastrous 74% losses, that the mainland government appears to be recognizing its mistake. Chinese Vice Premier Liu He's recent committee hearing indicates there will be better coordination and communication among Chinese ministries and regulators moving forward. We shall see.
It will be whether Beijing gets this response right that will determine whether the US$18 trillion Chinese economy and the US$18 trillion Chinese market capitalization is worth targeting again. I promised an answer, and I'd say it is a "yes," that Chinese equities can be considered again, with a proviso: The accounting issue must be cleared up, and Chinese regulators must start behaving with regularity, rather than making random pronouncements and last-minute, even secret policy shifts.
