China:The Han Bull

China

“He who will not economize will have to agonize”…Great Confucius

China the mighty Han Empire based on the philosophy of Spiritual leader Confucius has emerged over the last decade as a raging bull and has stormed into the world with its unique business model.China’s rise as the second largest economy in the world on the back of investments and consumption has been remarkable. China is not only the greatest trading power in the world but also one of the largest importers of commodities thus driving the world economy. Initially driven by investments in infrastructure which might be considered as the 8th wonder of the world which includes the largest railroad of high-speed trains and the tallest skyscrapers have shown the world how decisive and pro-reform policies can transform a country within a decade. China has recently shown a vibrant entrepreneurship spirit and this is the bellwether of a nation which is a superpower in terms of economy and the same has been seen in India.  China is fast innovating in technology and is no longer relying on cheaper products to gain competitive advantage. Xiaomi is one example. Today not only is Xiaomi the number one smart mobile phone in China and has redefined a fundamental industry through its unique distribution channel which helps it to market smartphones at unbelievably low prices with the best technology. The popularity of the product can be seen in India as it is sold within a few hours through online retailers Amazon and Flipkart.  Alibaba does more business than Amazon and will one day be the most dominant e-commerce site in the world while Apple’s huge surplus of cash is due to the outsourcing of all iPhones assembly to China.  China is fast innovating and has realized that it needs to change from being a low-cost manufacturer to create brands which known for quality and technology.

Much of achievement is due to its people and to a large extent to Chinese government which has shown a collective will (especially in the last 20 years) to make policies for the betterment of people and liberalizes with pro-reform policies. In terms of economic limits and infrastructure development, the Chinese government has outstood over the last decade. But a sense of caution here, opening up too fast is also a risk and slow and steady always wins the race and should reform in a structured way.

China’s recent efforts to make RMB convertible is commendable as well as its emphasis to boost consumption and services rather an investment. Looking at the recent turmoil in the equity markets, it will be prudent for the government to cut the number of trades by retail investors as retail investors join 80-85% of trades while the retail participation is only 13%.

Going Forward

China today is building some of the best educational institutes and are attracting faculty with PhDs from institutes like Columbia business school, Chicago Booth, Kellogg, and many more prestigious names show the strong foundation which China is relying on. China should focus on education and build more of these educational institutes going forward.

Reforms and Suggestions in equity markets

It is very important to make stricter KYC norms i.e. Know your client regulations for clients. With my experience in private banking in India ( a country at one time very similar in capital structure although that has changed now to China and being neighbors have very similar behavioral dynamics), it is always retail clients who suffer because most have been ill-informed and  manipulated by brokerages. Brokerages then play in margin funding or naked options (call options rolled over). All this is fine until markets are going up but when they turn it causes markets to fall steeply due to margin calls especially since you are not hedged. So better regulated environment like risk profile, taping of calls for clients etc will help to manage risk further and can help safeguard investor rights.

Second, is to create further diversification in wealth management products esp. in alternatives incl. structured products. This will help clients to diversify their portfolios and present more avenues to invest. Caution here since structured products are only for intelligent and savvy investors and should only be sold through top banks in China including MNC banks and not through NBFCs. In India, 85% of the structured products are equity-linked but China can take a call and come with a more diversified array of products. This will help in to manage risk better.

Increase institutional participation in capital markets and allow pension funds to buy a part of the equities like maybe 20% of their net asset value as a permanent feature which is done in developed markets.  Increase the limit of overexposure to equities for insurance companies.

Reducing leverages for retail clients and introducing increased taxation on buy/sell of shares to limit speculation and increasing short-term capital gains.  I am not sure about taxation structure in China, but to increase long-term participation in equities, the government could make long-term gains tax-free ( maybe one year and above).

Han Empire

China has been an economic power over the last 1000 years and history never lies. To give a perspective China and India controlled about 60-65% of GDP just 300 years back and are one of two oldest civilizations who lived in peace and harmony with great empires like Maurya (esp. Asoka the Great), Chandragupta and Chola kingdom in India and the might Han empire (esp. emperor Han Wu), Tang and Ming dynasty for 1000 years which is unprecedented in history and will surely continue going forward. Both China and India gave the world science, greatest architectural monuments, politics, and governance but most important spiritualism with great Lord Buddha, Guru Nanak, Guru Gobind Singh in India ( just to name a few) and spiritual leaders in China like Confucius and Laozi to name a few.

History shows that China has time and again reinvented itself and emerged as a global economic superpower. Han race is the largest ethnic race in the world may be about 1.6bn people worldwide. This shows that Chinese people are adaptive and embrace change. The only thing that is constant is change and Chinese people have according to statistics the best in terms of adapting to change. Going forward China might get old before it gets rich due to the one-child policy, China will surely adapt since as China grows it will ultimately attract people in China from around the world esp. people of Chinese origin.  In ten years about 100 mn English-speaking Chinese people will come into workforce making China truly globalized in terms of attracting talent. (Since language is a prime barrier today to work in China for foreigners)

China is a long-term bull and a country which built Great Wall of China invented martial arts esp. Kung Fu, gave the world Bruce Lee (the greatest action hero of all time and a role model who will stay iconic person forever) are here to stay for a very long time and we might be leaving in an era where the next 100 years might belong to China.

As we become more globalized, a day will come hopefully in near future that nationality or religion or ideology will not matter but your talent and passion. From the Engineering talent of Germans, Creativity of British, Haute Culture of French, Endurance & Strength of Africans, Capitalism of Americans, Bullfights of Spanish, Diversity of Indians, Love of nature and civilization of Scandinavians & Canadians, Soccer of Latin Americans, Resilience & Adaptability of Chinese, Video games of Koreans,  we are truly global. As we become more global and as we assimilate among each other through marriages etc resulting in breaking barriers, we will live a more peaceful and harmonious life.

Note:  Nishant Malhotra is MBA pass out of CEIBS, 2011 and is based in Pune, India. Nishant Malhotra has no exposure to any equity stocks in China and has not been involved in any recommendation of stocks in China as a professional. The view expressed is sole of Nishant and he has not received any funding towards the article. Whole or part replication of the above would amount to plagiarism. The article is more to do with qualitative research than fundamental research. Any disrespect for anyone is not intended and unintentional.