InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
OCTOBER 26, 2016
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
This week in IntelDigest, we will discuss China, the world’s second-largest economy and greatest enigma. Unlike Las Vegas, “What Happens In China” tends to affect the rest of the world, so it is in our best interests to understand that potential … for good or for ill … so that we can make informed investment choices over the coming years.
This is a country whose economy has grown at an Average Annual Rate of 10% over the last 25 years, whose currency continues to grow in stature, and whose influence around the world is approaching that of the United States. China is the largest exporter in the world, the second-largest importer of goods and services, and an early adopter of new technologies
However, as investors, we have to determine how much we can rely on continued growth, or trust the data put out by the government and Chinese corporations, or sidestep significant problems involving the credit and real estate markets in China.
Argument FOR Investing in China
It is possible that, in 5-10 years, the largest and most profitable companies in the world could be from China … Baidu (the Google of China), Alibaba (like Amazon, an online retailer), TenCent, owner of the wildly-popular messaging app, WeChat.
These companies are leaders in “The New China” … businesses which are not affiliated with state-owned enterprises like banking, energy, and telecom.
You may be surprised to learn that Alibaba is already the largest retailer in the world. Its gross merchandise volume has reached $500 Billion in the last year, passing Wal-Mart. Yet, it is still entirely an online business, like Amazon.com.
Alibaba controls 80% of online retailing in China. And, Baidu has a larger share of the Internet Search market in China than Google has in the U.S. Both companies have had a tenfold increase in sales over the last five years!
The potential growth in a country as large as China is incredible, as existing customers increase use of these services and hundreds of millions of new customers are still to come on line.
Another leader in the technological revolution in China is a company called TenCent, which owns WeChat. This app has transformed the way most people in major Chinese cities communicate and conduct financial transactions. It’s like having Facebook, Paypal, a telephone, and text messaging all in one app. WeChat is a platform which contains Ten Million third-party apps, and participating companies can easily add apps to the platform to facilitate transactions with customers.
Many Chinese communicate primarily through the text messaging functions of WeChat, rather than making voice phone calls. Rather than carry cash or credit cards, they make their purchases with a swipe of their smartphones. They can check the news, hail a cab, or manage their credit card bills within the main app.
This technological revolution has occurred in just the last three years!
The WeChat functionality is ahead of companies like Facebook; and, WeChat has a virtual monopoly in the most populous country in the world. TenCent, the owner of WeChat, is also one of the world leaders in mobile gaming.
As investors, we certainly want to participate in the growth potential of the leaders of “The New China.”
IMF Special Drawing Rights
Another advance for China was the recent inclusion of its currency, the renminbi (commonly referred to as the “yuan”) in the Special Drawing Rights (SDR) of the International Monetary Fund (IMF). The IMF created SDRs with the aim of providing a future global reserve currency … in fact, as a future replacement of the U.S. Dollar as the reserve currency for the world. The yuan is now included in the basket of currencies which will be used to determine the value of the SDR.
We will discuss Special Drawing Rights in a future issue of IntelDigest; for now, we can tell you that a SDR is valued using these five currencies: U.S. Dollar (41.3%), Euro (30.93%), China Yuan (10.92%), Japan Yen (8.33%), and U.K. Pound (8.09%).
Argument AGAINST Investing in China
We should all be aware, however, that there is trouble brewing in China, which could trigger the next recession around the world.
The Bank for International Settlements (BIS) and the IMF have raised warnings this year about the level of debt in China. Outstanding loans in China have been rising rapidly over the last eight years, and the debt has reached $28 Trillion. Corporate debt is 171% of the GDP of China; total debt is 255% of GDP.
A recent BIS report pegs the “credit to GDP gap” in China as 30-to-1, meaning that the credit bubble in China far surpasses any other country in the history of such metrics.
Plus, China has committed itself to Trillions of Dollars in infrastructure projects. The New Silk Road project, which is meant to connect China to European markets via a series of modern roads, ports, railroads and pipelines, is estimated at One Trillion Dollars (before cost overruns). The leadership has also promised massive spending in the interior to raise the standard of living of hundreds of millions of its citizens.
We have previously discussed in IntelDigest the fragile state of economies around the world. From Zero- and Negative-Interest Rate policies, and massive bond purchases by central banks, and historically low bond yields … to decreasing corporate profits while stocks are at historical highs.
The danger is that, if China loses control of its over-extended debt situation, it could cause a shiver in these fragile economies which would result in a stock market crash and a Greater Recession.
Caution is Warranted
We believe that caution is warranted in investing in China, especially in more traditional industries which may be burdened by some of the massive debt referred to above. For our part, our investments in China are mainly in the technology area, where there is room for explosive growth in the coming decade.
In either case, investors should be expecting a stock market shock in the coming months, and pay proper attention to their positions in Chinese assets, as well as other markets.