For those of us who have never worked in China or invested in that vast country, China remains for us a fascinating and somewhat forbidding nation. In this piece, Steve Watson, a portfolio manager at Capital, shares his experiences of travelling to and investing in China over the past 40 years. He begins by recounting what China was like 40 years ago: “Steve Watson was a young student when he and his wife, Barbara, first arrived in Wuhan, China, to spend the summer of 1981 studying Chinese.
“The China we encountered on that first visit would be unrecognizable to a traveler today,” recalls Watson. “We traveled on unairconditioned trains powered by coal-fired locomotives belching smoke that burned your eyes and blackened your clothes.”
There were no private automobiles; bicycles and buses were the primary means of transportation. The city had no subway system. Telephones and air conditioners were out of reach for most people — Wuhan University had only one air-conditioned room at the time — and refrigeration was scarce. The city, a central trading hub in China, had a single bridge spanning the Yangtze River.
Today the city of more than 12 million boasts 11 bridges crossing the Yangtze and a subway with nine lines and 228 stations. Air conditioners, TVs and cars are in abundance.”
Watson’s first observation is that the Chinese have a huge appetite for change and adaptation and this cultural trait allows the country to produce great entrepreneurs: ““Even after decades of closely following China, I am often surprised by its capacity for change and willingness to adapt,” says Watson, …we place a great deal of emphasis on investing with great business leaders, and China has produced some great entrepreneurs.
One example is Wu Yajun, co-founder of Longfor Properties, whom I met on one of my first trips as the new Hong Kong property analyst in 2000 when the company was still nine years from its Hong Kong IPO. I was struck by Madame Wu’s integrity, determination and dedication to her customers and employees. That assessment proved to be accurate in my view, and Wu is among the property developers who transformed the face of China over decades of explosive growth.”
Secondly, China is vast, complex and hence easily misunderstood. For decades now, says Watson, ‘experts’ have been saying that China’s collapse is imminent. Repeatedly such commentators have been proved wrong: “For years pundits have predicted China’s imminent economic demise. As early as 2001 in his book, ‘The Coming Collapse of China’, author Gordon Chang described how the grip of the Communist Party, bad debt in the banking system, capital misallocation, corruption and property bubbles would conspire to end the Chinese economic miracle.
Contrary to the expectations of Chang and many others, the country resisted collapse. While many of these problems are real, in my experience its leaders were — and remain — focused on avoiding decline. We can watch with concern the danger zones, especially debt buildup and the misallocation of capital, but we should remember that China’s policymakers focus on those same issues.
Indeed, China’s stratospheric growth has often confounded close observers expecting collapse or stagnation. Consider China’s property market, which early in my career I covered as an analyst. The fear of an imminent property collapse has been with us at least since the early 2000s. In 2003, a colleague of mine, reflecting on a trip to Shanghai wrote that he had witnessed mile after mile of new apartments, offices and factories, many of which appeared unoccupied. “I think I am witnessing a bubble of major proportions,” he wrote at the time.
Chinese property prices instead rose dramatically over the years, stubbornly refusing to collapse. It was difficult for many to comprehend the transformative effect of urbanization, alongside a general need for upgrades to the national property stock. Arguably, the country remains under-urbanized today.”
Thirdly, Watson says the Chinese Government wields enormous power and uses this power to intervene actively in the economy. He implicitly says that the Chinese Government still hasn’t quite figured out how to intervene appropriately in the economy: “Recently, Chinese authorities imposed tight regulations on internet platform companies they felt were out of line with the government’s common prosperity agenda. In some cases these businesses were deemed too profitable or conducting business at odds with the public interest.
The shifts in government policy surprised many, including me, and shares of the platform companies tumbled. The government also intervenes in other areas of the private sector like education and gaming.
As investors, we must pay close attention to these changes and fully understand the implications of China’s common prosperity agenda. Without a doubt, political risk is higher than in other markets, but China wants a growing and dynamic economy, characterized by a significant degree of innovation. I believe its leaders know this cannot be accomplished solely by state-owned enterprises.”
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