Strange doings in China. And they should have you scratching your head and asking “How do you invest in this market?”
I’m not talking about Google’s (GOOG) decision to stop self-censoring its China search engine and retreat to Hong Kong in the hope, delusional I suspect, that the Chinese government will let Google Hong Kong operate outside the censorship rules.
And I’m not talking about the spying bribery trials of four Rio Tinto (RTP) executives and employees that have resulted, so far as anyone can tell since today the proceedings were moved to a closed court, in guilty pleas from some defendants on bribery charges but denials of the commercial spying charges. Speculation, and that’s all it is at this point, is that, given a recent deal between Rio Tinto and Chinalco (ACH), there’s some kind of deal that would let the Australian defendants off with a lesser sentence (although who wants to spend any time in any prison, especially a Chinese prison) in exchange for testimony that would implicate Chinese steel company executives in bribery charges.
Those two cases—Google and Rio Tinto—should be enough to make an investor wonder how anybody can make money in a country where the government gets to make up the law as it goes. But the implications of those cases are nothing in comparison to the ramifications of a much lower profile case, the takeover of privately owned Shenzhen Airlines by government-controlled Air China (AIRYY.PK).
In 2005 a private company, Huirun, beat out Air China in a bidding war and bought about 65% of Shenzhen Airlines. (Air China wound up as the second largest shareholder with a 25% stake.) That effectively turned Shenzhen Airlines from a state-owned company into a privately owned company.
But the Chinese airline industry has been undergoing rapid consolidation since 2008 with state-controlled companies buying up smaller, often privately-owned companies. In 2009, for example, state-controlled China Eastern Airlines (CEA) bought up Shanghai Airlines.
Many of these deals haven’t been exactly voluntary, I’d say. In 2009, for example, Lan Shili, the owner of East Star Airlines, disappeared in the middle of merger talks with Air China. Before his disappearance Lan had set a price of $88 million for his company. After his disappearance, East Star wound up going into bankruptcy. Air China bought the company out of bankruptcy for just $3.4 million in December.
Something similar has happened to Shenzhen Airlines. Here’s the story as laid out by the Financial Timkes.
In December, Li Zeyuan, the head of Huirun, was placed under investigation for “economic crimes.” Two weeks ago, the top Huirun executive at Shenzhen Airlines, Li Kun, was named in the same investigation.
That has left management of Shenzhen in the hands of Air China executives (Air China owns 25% of the airline, remember.)
And what do you know but yesterday Air China announced that it would take over Shenzhen Airlines by paying $100 million to raise its 25% stake to 51%. Air China is likely to expand that position further since Huirun itself has now filed for bankruptcy.
It’s pretty clear that China, which once had decided that it was okay for privately-owned companies to operate airlines, has decided to renationalize its airline industry around the three big state-controlled companies, Air China, China Eastern, and China Southern (ZNH).
So what do you do if you’re an investor that wants to own a piece of the world’s fastest growing economy?
There’s the cynical approach. You can go with the big guys and buy into the companies like Air China that are favored by Beijing. Assuming you can figure out who’s in favor and who’s not. In some cases I think it’s pretty easy. It’s no coincidence, for example, that former Air China head Li Jiaxiang is now in charge of the General Administration of Civil Aviation of China, the government body that regulates the airline industry in the country. So you buy shares of Air China because you believe that this company has the government connections to rule the airline industry in China.
And there’s the stay out of the big sectors the government cares about. It’s pretty safe to think that Beijing things steel, railroad equipment and construction, Internet and telecom equipment, and solar and wind power gear, just to name a few industries, are strategic sectors. It’s unlikely that China’s government would let a private company dominate any strategic sector. Privately owned successes in those industries face the fate of China’s privately owned airlines.
But dairy producers, cosmetics retailers, noodle companies, certainly you can invest in those without worrying that Beijing will decide that they represent strategic industries that need to be under government control. Especially if you buy companies in these sectors while they’re still relatively small.
That’s true enough—and safe enough—as long as you believe that what’s going on is simply a government making sure that its strategic sectors stay in government hands.
But some China watchers, such as Minxin Pei, think that what we’re actually witnessing is politically connected individuals using the government to make them rich. If that’s what’s going on, then staying out of strategic sectors won’t be enough. (I review Minxin Pei’s book China’s Trapped Transition in June 2009. Read that post here https://jubakpicks.com/2009/06/29/books-on-china/ )
Me? I’d go with the second strategy and just add government-sponsored theft to one of my list of the risks that come with investing in China. That does raise the bar at bit, I’ll admit, for deciding what’s worth buying in China and what’s not.
wwlettsome:
You mentioned in your above posting why article on China often turned into a China bashing feast.
Well, it also flushes out people like panjwar who seems incapable of adding facts and intellect to the debate.
DJBarber- it is always a function of how you look at things. I was buying in October, and have been taking some profits since about July… building up my cash position for the BIG ONE! So I guess we both lucked out with our “timing”!
I personally wouldn’t touch much in this market with the proverbial ten-foot pole. I have a few more “mid-term” items working, but it won’t matter a lot if I don’t make a killing in the next few months- I can wait for several years. But- that is just me, not you and many others.
So there you have two things: little differences of style and opinion, and when you need your money, are what make markets in the first place; and now you’ve got a first-hand example of a real geezer sitting on the sidelines with real cash, having a real fear of this present rally [but waiting, with Mr. Buffet.] When the blood runs in the street again, I will be redeploying.
DJBarber,
Congratulations on your “timing” success. As for the “cash on the sidelines” – that is the cash of people who were severely “burnt” and maybe not returning for a long time (remember what happened thru 70s and early 80s). Also, supposedly, lot of this cash is of “baby boomers” for going to safeguard it for their retirement….
More importantly, it is better that the money does not chase this market, because if it reverses (yes, it will with growth slowing, stimulus ending, taxes increasing, unemployment being stubborn, etc…) then these late comers will be the first one to head for the exits and further aggravate the falling market. AND then this money is NEVER coming back again. It is always the last ones to invest who mess things up!!
So I prefer a meandering/muddling market till recovery really really takes hold.
– cjxland on 24 March 2010
“DJBarber- “blood in the streets” was October 2008 and March 2009. I take it you were out of the country?”
Wasnt out of the country, WAS out of the market. Sold everything In early October 2008, bought everything back in March – June 2009
(First time in 20 years that I timed (Read lucked out) the market well.)
I was speaking more to the sentiment of this article; apparently most Americans are still experiencing the “blood in the streets” reaction and are not trusting of this market (Which has recently hit 17 month highs)
So, there is still an enormous amount of “private” cash on the sidelines not willing to be in this market but watching it go up.
With that much cash waiting, there will come a point when it is redeployed…
I apologize to all other readers for my long posting. When you face vicious accusation, you have to defend yourself however long it may be.
panjwar:
I was on vacation and am currently extremely busy, but I’ll answer you briefly here.
Please read all my past postings before making any accusation! (I think this blog does keep all postings. We can “tag” out what I posted.)
I have never defended any murder, ciber crime, or any violation of human right or whatever, nor will do so in the future. I merely said that Washington’s tough stance toward China is BAD for American businesses in China at time all countries are competing for the Chinese market. (Do you know how hard the Japanese, Koreans and Europeans work in China? Do think bashing China like you did is going to help you sell anything in China?) I also said that China buys a lot things than we think. From airplanes, autos, industrial machineries, to all kind of commodities and luxury goods (yes, luxury good! Jim’s recommendation Coach is just one of many.) This can be easily found on many major financial sites including Jim’s. Bashing China like you did are not going to help. Bashing make you even more look like a sore loser.
If you are an American, I have to say that your accusation flushes out how narrow, short, simple and isolated mind you have. If you are from those countries which view themselves as China’s competitors, I have to simply dismiss you because we all know that all China’s competitors are falling behind. I know it’s not easy to be a loser.
Regarding the corruptions (for the records, this is the first time that I ever commend on it), I simply think they are EQUALLY bad in both China and US. The only difference is that corruption in China is less sophisticated than here in America. Therefore, I suggest the Chinese officials (particularly those in provinces.) to learn the ART of collecting money from their US counterparts and upgrade their “tools” on par with US’. Few examples here. (1) Instead of getting a “red envelops” filled with cash, pass laws that allow you to collect much larger sum completely legally. After all, the “red envelops” are too small to hold a lot of money. Political action commetties (aka, PAC) can collect much, much more money and you don’t have to worry about being caught! (2) Don’t drop hint to businesses about sending you a gift. Instead, passing laws even just the THREAT of passing law to HURT their business, they’ll pour money into your campaign coffer or whatever your favored pet projects in a hurry! (3) Don’t execute anyone that really give you bad name. Instead, launch investigations, law suits, audits, so the person will quickly exhaust his resources and stripped all his dignity, becomes a “dead man” walking. (4) Don’t just directly spend the money you collected that really makes you look like a low life. Do it in high fashion. Pass some laws or rules, so you even your spouses and children can fly on other people’s private jets, vacation in other people’s private retreats, on and on. Tens thousands a night? No problem. $100K+ in-flight meal and liquor? Done! Thousands of dollar on flowers in few months? That’s just a tip for public servants’ hard work! You see how different it can be?! (5) Don’t arrest anyone for failing their duties. Instead, you need to learn how to protect each other by scratching their backs so next time when you fail your duty, they’ll scratch yours! 911, financial melt-downs, all will be history. History meant to be forgot particularly when people are too busy or never taught about. Want more?
DJBarber- “blood in the streets” was October 2008 and March 2009. I take it you were out of the country?
I, for one, don’t even believe that was the real blood-in-the-streets capitulation, altho, as your article points out, a lot of investors did just that, and have so far not had the…whatever…to jump back in.
I don’t think we really learned our lessons in 2008- we didn’t really change anything that got us into the mess; not at the top, not at the bottom. So I’m one of those who is expecting the BIG ONE in the next several months to a couple years.
No reason we can’t all make a $buck or two in the mean time.
Matthews China Fund is my largest single holding. I’ve held it for a number of years and think its a great way to play the Chinese market since at any time their government can mess up any single investment. I’ve made good money on the China fund. If I had sold when it peaked a couple of years back, I would have made a lot more.
Not sure why these things frequently turn into a US vs. China or a bash China or bash US posting fest. The article points out a valid investing risk in an emerging economy and we have seen similar things happen in other emerging economies. The big question is will China be successful in limiting this kind of activity for it’s own long term self interest or will it become rampant and cripple the long term growth and innovation of the Chinese economy. Lots of investors (both Eastern and Western) love the modern Chinese economic miracle but can they stay on the course that they have so successfully been navigating?
What I hear is that China has got the most up to date code of laws; problem being that courts pretty often ignore it.
Regarding all the evils described in Jim’s post, you find them all in China’s past history, which goes back 2500 years: more to do with philosophy than political systems.
“Americans Say They Missed 73% Rise in S&P 500 as Economy Surged ”
http://www.bloomberg.com/apps/news?pid=20601087&sid=aTp.Sf7cvYvU&pos=6
I wonder if this is indicitive of proverbal “blood in the streets”
If I didn’t (Think I) know better, I would think this would be the time to “buy buy buy”….
But, still, I hesitate….
ifxeyes
The Judicial System in the US doesn’t “make up the laws/rules as it goes along” although it does offer interpretations of the laws. The Legislative Branch of which the US House of Representatives is a part is in fact the branch of government that is charged by The Constitution with making the laws which are then signed off on (or not) by the Executive Branch. While it is true that some of the members of Congress are not the most desirable characters, they were voted into office by their constituents. This is not analogous to what Jim is describing about China, or the oligarchs in Russia, or Venzuela, etc.
My ten year experience with Matthews Funds has been good. They have a team that investigates the companies on the ground and “kicks the tires”. So you get more than a “just what’s on the papers” evaluation.
blackmouth,
Couldn’t have said it better myself.
dmartin11,
It ‘saddens’ me to hear Alcee Hastings on the Rules Committee last weekend working on the healthcare bill say, “Uh…when the deal goes down, all of this talk about rules, we make them up as we go along.” He, by the way, is a Democrat Representative from Fla.’s 23rd District and former Fed. Judge who was impeached for bribery and perjury. Is this a great country, or what?!
I am not sure why the frequent poster YX is not defending these charges, potentially murder, plus currency manipulation, cyber terrorism etc., etc for China.
Jim,
how does this affect your recommendation for STP? you have it in your Jubak Picks 50, and they reported earnings recently that I thought looked reasonably good, and it still appears to have a reasonable valuation (but significant risks with uncertainty from many future scenarios). I would appreciate any new thoughts you have. (I own STP shares).
What would be the benefit of holding Matthews China fund ( MCHFX) vs an ETF like PGJ? I compared them in a price performance graph, and in 4 Yrs they are the same. In the last year MCHFX has done better, but in a 2 year time frame PGJ beats MCHFX
Ed and Mukerji,
The following explanation might interest you:
http://articles.moneycentral.msn.com/Investing/JubaksJournal/PutJubaksPicksToWorkForYou.aspx?page=all
One of the things that saddens me most is USA cynics. True, the US is far from perfect, but the US has done so much in the way of enacting laws to TRY and prevent monopolies, bribery with public officials, and so many other illegal activities that undermine free enterprise and competition. It is one reason I am still optimistic about the future of the US economy, desptite the handicaps we’ve given ourselves recently. You can never stop the selfish greed rampant in human behaviour, but you have to be happy that we in the US live in a land that at least encourages and supports fair business by private individuals instead of openly allowing governments to do what they wish. Yeah, yeah, the government chose which banks to bail out and did “nationalize” some car companies, but these guys would have gone bankrupt without intervention, or so the story goes. It is far different from the government forcing a whole sector to become nationalized and pushing out private competition entirely. We’ll see if today’s alarmists are right the health care turns into a “government takeover”. I refuse to believe that is our future in the US.
Ed- Mr. Jubak recommends funds for every occasion in his book, tho he explains [and why] that his personal preference is a more concentrated specific stock portfolio [he’s a lot better at the research than I- and many of us- can be, for one thing.] Jim has a lot of great reccommendations there, that mesh nicely with his Picks- place to start.
Mukerji,
You know Mukerji’s question and others I have seen, and my own actions suggests most “portfolios” are really suggestions not anything that most people can really invest in directly like you might for a mutual fund.
Since everyone has a different situation, we each pick and choose instead of taking every buy and sell as an automatic thing. If my other investments outside of what Jim suggests are already concentrated in the energy industry, I might not buy Jim’s suggestion for such a stock for instance. And I would think people would know that the same is true for Jim too, that is why it is not a contradiction to recommend buying a stock, even if he wouldn’t buy it.
And then there is that big “past performance is not an indicator of future performance”, which really begs the question of how do you even start investing in such a portfolio. Say if you just found Jim’s portfolio today, the stocks in it are not all buys, they were buys when he said they were, but maybe not so today.
I guess I like what Jim said in his book as in you have to ease into it based on current recommendations and your own situation, not buy everything in a portfolio.
Jim thanks for everything you do. For the weak of heart who like to follow with digested info served…what do you mean when you say…will add to my personal portfolio…. sometimes even after what seems like you are pretty much calling an equity a strong buy…you do not own it? Please clarify…hope I am not intruding into a personal area that is meant to be kept away from this site.
Jim,
I checked those Matthews funds. Are there any more outstanding funds you’re not telling us about? And why aren’t they in your Jubak’s Picks?
Jim,
After reading this post by you, I recall a similar post by you about governments cheating on their books:
https://jubakpicks.com/2010/03/09/the-lesson-of-the-greek-crisis-everybody-government-cheats-and-no-one-wants-to-know/#more
Mind you, I’m not referencing this as a defense of China. I’m just pointing out that we can sit here all day and pick over government corruption everywhere. Find me the honest country so I can invest my money there, ok?
cjxland, I own Matthews China, India, and Asia Income. Have for years. (Well, not India, it’s new.) Have been very happy with the results. Would recommend them.
Jim- another possibility for us little guys is to utilize the expertise of various Old China Hands to mitigate some of the risk involved. I prefer to do my Asia investing with the funds of Matthews Asian, specifically MAPTX- Pacific Tigers- which also helps mitigate other risks, by market and country diversification.
They do have country-specific funds as well, for those less wimpy about more concentrated or targeted selections. Yes, there are mutitudes of lower-cost ETFs, but they are mostly new, mostly indexes [hand-picked, I betcha, in offices in San Fran and NYC]; I doubt they have the in-depth, hands-on China and Asia experience of Mr. Matthews and his group.
Jim, your list of stories sounds very similar to what was taking place in Russia during the Putin years. Once the government decided to take complete control over the industries that dealt with natural resources a series of trumped up charges begin eliminating anyone not aligned with Putin’s political/economic machine. Then the foreign firms that had invested billions for mineral rights after also investing technological skills suddenly found themselves being given the boot.
Of course, you could always look closer to home to see the exact same patterns today in Venezuela.
blackmouth,
There is a difference between China and U.S.A., here in the U.S.A we “believe” we know what the rules are (or will be). 🙂
How do you invest in a county such as the U.S.A. that’s making up the law as it gos along?