Image Source: Mike Behnken
Our concerns about China are not new, and neither are your concerns.
The potential Treasury Secretary-to-be, Carl Icahn, that is one in a world of a Donald Trump presidency, which has become all-the-more likely now that Ted Cruz and John Kasich have stepped aside, recently brought to light the differences between a capitalist society such as that of the US and a communist nation such as that of China (FXI). Unlike the US government which isn’t necessarily anti-business, even if it isn’t pro-business if existing corporate tax rates are any measure, the Chinese government can make things awfully hard on any company doing business within its borders, if it wants to.
What Icahn has been referring to may partly be the driver behind the significant weakness in sales from Greater China in Apple’s (AAPL) calendar first-quarter results, “Apple: Nowhere to Run, Nowhere to Hide,” something we didn’t like either. To be a global company, however, Apple must do business in China, and accepting their laws and potential punitive governmental actions is simply par for the course, whatever they are and at what price they come. China can be tough, and maybe it has been more about presidential hopeful Donald Trump’s rhetoric about China that spooked Icahn into selling all of his shares in the iPhone giant than anything else. Icahn knows that nobody wins in trade war, and he wanted out… that’s just one man’s opinion, however, and he thought Apple TV would be a near-$40 billion revenue stream by fiscal 2017 (we know how things turned out there).
There have been several other data points in China that continue to weigh on investor sentiment. A popular gauge that measures activity in China’s manufacturing sector slipped to 49.4 in April from 49.7 in March, implying ongoing economic contraction…for the 14th consecutive month (any number below 50 indicates contraction). Published numbers on China’s pace of economic growth, however, continue to be in the high-single-digits, almost detached from reality, and as more-developed countries across the globe teeter between a paltry pace of expansion and/or outright recession. The US measure for economic growth in the first quarter of 2016 came in at 0.5%, by comparison, and the country continues to be a beacon of strength thanks in part to a largely diversified economy, one not levered heavily toward commodity-oriented businesses. We continue to cast a skeptical eye on China’s reported economic growth figures – they make little sense in the context of the world around it.
But that’s not all that investors have been worrying about. Though we can’t say for certain whether there has been any wrongdoing, Baidu (BIDU) is being investigated by China’s Internet regulator “over the death of a university student who used the Chinese search engine to look for treatment for his cancer.” According to reports, the patient had “accused Baidu online of promoting false medical information, as well as the hospital for misleading advertising in claiming a high success rate for the treatment.” We cannot substantiate any of the claims, of course, but it may not matter. If China’s Internet authority wants to make changes to further limit the reach of the Internet, it could spell bad news for many Chinese e-commerce based equities. The government’s crackdown on widespread fraud and counterfeiting (fake goods) continues to impact the pace of expansion at Alibaba (BABA), while increasing cross-border e-commerce regulations are putting a damper on JD.com’s (JD) true growth potential.
China’s debt bubble continues. As the People’s Bank of China continues to execute stimulus after stimulus, the country’s debt has ballooned to record highs, according to a Seeking Alpha note sourcing the Financial Times. “China’s total domestic and foreign debt grew to a record 237% of GDP in Q1, the FT calculates, or 163T yuan ($25 trillion).” We covered in part the debt binge in the US, “Debt, Debt and More Debt (April 2016),” but perhaps China is in much worse shape. According to reports, debt-to-GDP in the country advanced by more than 100 percentage points in just under a decade, and that considers a GDP that likely can’t be confirmed genuinely by outside, independent sources. It’s very likely that China’s debt-to-GDP is much, much higher, and the world won’t truly know about it until it’s too late. Many are calling for a “hard-landing” in the country, and it may just happen.
Be smart with your money. We have only indirect exposure to the country, having moved out of both Baidu and Alibaba in the Best Ideas Newsletter portfolio in recent years.
Related ETFs: ASHR, YINN, EWH, CAF, FXP, YANG, KWEB, PGJ, GXC, HAO, CQQQ, MCHI, PEK, CHN, CHIQ, CHIX, TAO, QQQC, TDF, XPP, ASHS, CNXT, YXI, CHAU, YAO, CN, FCA, GCH, CHAD, ECNS, CXSE, CHII, CHIM, KBA, CHIE, EWHS, JFC, FCHI, KFYP, AFTY, FHK, ASHX, XINA