One absolute certainty for the year ahead in China is that there will be new bubbles – some driven by individual investors, some driven by corporate investors.
Investors want to know where the bubbles will be so they can get in early. Government wants to know so they can intervene before the bubble inflates too far. In recent years, we have had the ramp up and down of the Shanghai stock market, of commodity prices such as copper, and of the housing market.
Wealth management products
With the Chinese government continuing to create new credit in the economy at a rate that is at least twice the pace of underlying economic growth, and the tap being largely closed at the moment for this money to flow out of China, more and more capital is sloshing around in China looking for where it can earn returns. And with restrictions on investing in property remaining in place for now, the main historic channel for investing is shut off. This is happening in a year when inflation seems to rising.
Regulators have also tried to shut off some of the very popular debt products (generally called wealth management products - WMPs) issued by insurance companies, banks and asset managers. Insurance companies will no longer be allowed to issue WMPs with a guaranteed minimum return. Some of the riskiest products have had limits put on the extent that they can use leverage to ramp returns and asset management products have been restricted from investing in other asset management products, a kind of regulatory arbitrage that has now been shut off.
Individual investors are increasingly turning to individual financial advisors (IFAs), for whom it is a golden era. In a market with over 5,000 hedge funds and thousands of VC and PE funds, investors desperately need guidance. At two of the market leaders, Jupai and Noah, commissions grew 88% and 96% respectively in the past year. And both are expanding from the traditional high net worth individual focus into the mass market. Both are expanding into Hong Kong and New York to manage mainland investors’ overseas assets also.
Some investors are selectively moving back into stocks. They believe the government will, as it has in the past, cover them against the downside, and so are moving to the more speculative end of the stock spectrum, the technology stocks of which many already trade at 50-70 PEs. The Hong Kong Stock Exchange is also seeing an impact.
As mainland retail investors get more comfortable investing in Hong Kong through the Connect arrangement which permits this, on some days up to 10% of trades on , averaging 5-6% in recent months, are mainland originated. It is becoming a significant factor in the performance of the market, and after all, around 75% of the Hang Seng Index is mainland related stocks.
Conversely, it is likely to be a bust year for hedge funds, with more managers following Xu Xiang, the founder of the high profile Zexi hedge fund, into court to be fined (in his case over USD1.5bn) and sentenced to jail.
Too many funds lack a track record, have raised too much capital, and will feel the need to cut corners to deliver returns. China’s increasingly effective regulators will be on to this. It not only makes them aligned with the top down anti-corruption campaign but it is popular with investors.
Investors could put their money into the P2P lending platforms, but again, over-supply of capital and of platforms leads to lower quality, resulting in higher risk lending that will end badly for some.
Perhaps gold? China imported 1,300 tons of gold in 2016, which sounds like a lot, but was down 17% on the prior year. While gold could be seen as a hedge against RMB depreciation by Chinese investors, its recent dollar performance has not been great: at $1200 it is down a quarter from 2012 peaks.
And technically it is illegal to export gold from China: once it’s in, it’s supposed to remain here. Gold is also a global deep market; it would be hard even for Chinese investors to create a major ramp in its price.
Given all this, it would not surprise me to see China driven ramps in prices for various agricultural commodities, especially if tit for tat trade issues escalate with the US. Investors might argue that China will not be able to or want to access US supplies of various commodities, and will need to purchase elsewhere if possible, disrupting global flows and potentially creating temporary supply shortfalls in mainland China.
Prices of modern Chinese art (at least the politically correct kind of art) could also benefit this year. Relatively thin markets that it doesn’t take much to move them. Local auctions houses benefit as much as the buyers and sellers from a rising market. Likely to happen.
This really should be a year for corporate debt markets to develop fast. High quality borrowers should be able to easily access capital directly from lenders looking for blue chip places to invest that at least offer returns that are a little more than a bank deposit. And maybe, for some inflation protection, offer some index linked bonds.
In the end nothing is likely to be able to absorb all the available credit. Bubbles will occur in areas I haven’t been able to imagine and in the end, property will receive the major share. Developers clearly believe this – land sales by Chinese local governments across 50 cities were up over 70% in the first 2 months of the year. They don’t expect restrictions on construction or on individuals’ ability to buy property to remain.
Expect more bubbles and more property sales by the second half of the year.