China May Be 'Uninvestable' After All

Earlier in March of this year, JPMorgan Chase shocked investors and attracted controversy in the financial media for labelling Chinese internet companies as "uninvestable."To get more international business news china, you can visit shine news official website.

We at Stratos Capital Partners not only agree with this assessment of Chinese internet companies, but we also view Chinese equities more broadly as becoming an 'uninvestable' asset class. Investors with exposure to Chinese equities should consider cutting losses as China's economic rebound becomes ever more elusive.

Despite what we view as good intentions by its research team to warn investors of the dangers of investing in Chinese internet companies such as Alibaba (BABA), Tencent (OTCPK:TCEHY), and Meituan (OTCPK:MPNGF), JPMorgan eventually succumbed to mounting pressure from prospective clients, nationalistic Chinese netizens, and quite possibly entities linked to Beijing. JPMorgan upgraded those companies two months later claiming that the original call was published in error.

At the time of writing, Seeking Alpha's Quant Rating has a 'Hold' rating for both Alibaba and Tencent, and a 'Strong Sell' for the broader KraneShares CSI China Internet ETF (KWEB).

Valid Reasons For Being 'Uninvestable'
This is not the first time analysts have issued dire warnings against investing in Chinese stocks. From our standpoint as advocates of long-term investing, we too share the view that what qualifies as a high-quality investment, necessarily requires some level of visibility into future cash flows or prospects of the asset in question. When it comes to investing in China, though, the future is wildly unpredictable given the lack of transparency, weak accounting standards, and poor regulatory oversight. Worse, the fate of the Chinese economy is almost entirely dependent on the political aspirations of a single man, Chinese President Xi Jinping.

And Xi Jinping's actions of late have been nothing short of disturbing for investors. Even former Morgan Stanley Chief Economist and long-time optimist of China, Stephen Roach, has recently issued warnings that China's actions are signaling the early stages of a cold war.

Political Risks Overshadow Economic Potential
The political risks associated with doing business in China have relentlessly haunted the minds of business leaders over the years. In fact, most observers would agree that the uncertainties of doing business in China, are for the most part political in essence rather than economic.

Investing and doing business in highly authoritarian regimes is a double-edged sword. On one hand, decisive leadership means economic policies can be proposed and implemented quickly without having to accommodate conflicting interests (workers vs firms, savers vs lenders, welfare vs taxes, fossil fuels vs environment). On the other hand, authoritarian states often prioritise political interests over good economics. This means that economic policies may initially welcome foreign investors during the boom years, but quickly switch towards preserving political power and control during a crisis.

For long-term investors, we believe that the risk-to-reward for investing in Chinese stocks is no longer as attractive as before. As we begin to see more evidence that Xi Jinping will prioritise political interests over economic development, investors will increasingly be caught off-guard by sudden policy changes that could undermine their investments. As the chart below demonstrates, investing in China hasn't been worth the risk over the years.
The pandemic has demonstrated how China has become more unpredictable for investors. Chinese authorities initially responded to news of the virus outbreak by downplaying the seriousness of the situation and limiting the flow of information. However, when the containment strategy failed, draconian orders were issued to lock down cities and deploy manpower (military & public health) to enforce harsh quarantine measures and maintain order.

When several countries began to explore possibilities of managing an endemic Covid by limiting the effects of the virus with vaccines, Beijing doubled down on its zero-Covid strategy, insisting that the safety of its citizens is a top priority while pointing to the high COVID death rates in the U.S as proof of the democratic world’s dysfunction.

Fast forward to the present environment, nations with high vaccination rates are reopening their economies and businesses are on the path to recovery. In hindsight, China’s zero Covid strategy makes little sense especially given that the modern global economy has become so deeply interconnected by trade and air travel. But having raised the stakes of pursuing a zero-COVID strategy and having already suffered heavy economic losses, there was no turning back for Xi Jinping given the risk of losing political support within his party. By now, Xi Jinping’s priorities seem clear to me: Politics must come first, and the economy can wait.