Regulation is a four-letter word in American politics, but in China, is it business as usual?
This year, Xi Jinping – the leader of the Chinese Communist Party – passed down a laundry list of regulations that resulted in cascading unintended consequences for businesses and investors alike. These new regulations address real estate construction leverage, private education, environmental concerns, data privacy, and even screen time for minors. Needless to say, investors are not so happy about all of this, nor is the mainstream media.
But, what is the real story?
Is this a step backward towards Maoist communism, or is this par for the course for “common prosperity?” More importantly, for investors, the performance of Chinese equities has languished as of late. And, as China goes, emerging markets typically follow. The big question now: Is this a contrarian opportunity, or is this a value trap?
Tune in to find out.
Sit back in your Lazy Boy, lay down on your office couch, or walk your dog (or cat if you are into that), and enjoy the show.
Regulation is a four-letter word in American politics, but in China, is it business as usual?
This year, Xi Jinping – the leader of the Chinese Communist Party – passed down a laundry list of regulations that resulted in cascading unintended consequences for businesses and investors alike. These new regulations address real estate construction leverage, private education, environmental concerns, data privacy, and even screen time for minors. Needless to say, investors are not so happy about all of this, nor is the mainstream media.
But, what is the real story?
Is this a step backward towards Maoist communism, or is this par for the course for “common prosperity?” More importantly, for investors, the performance of Chinese equities has languished as of late. And, as China goes, emerging markets typically follow. The big question now: Is this a contrarian opportunity, or is this a value trap?
Tune in to find out.
Sit back in your Lazy Boy, lay down on your office couch, or walk your dog (or cat if you are into that), and enjoy the show.
Welcome, everybody. Welcome back to the podcast, Deconstructing Alpha, where we have unscripted conversations with whom I believe to be brilliant investment managers and we've got a great show for you today. We have the return of Andy Rothman, who is our specialist on China that we go to and many of you know that China has been in the news lately. So we're gonna break down we're gonna deconstruct some of what's going on in China. To start off, I'm joined today by Shannen Caroll. Hi, Shannon. We're back at the Go Be Wyo studios in Sheridan, Wyoming, which is very slowly becoming a podcast center of Wyoming.
Yeah. I'm just gonna say it's gonna be weird when you're not here we've recorded here so often.
I know, I know, and it's so much fun just to be in person here, so right before we started recording this podcast, I had to remind myself of what it was called, What's a podcast called again?
Deconstructing Alpha.
Okay, but for some reason, you know, when you just can't remember the basics. So, Shannen, do I look overly tan today? I don't think you do. Alright, well, I had a week off and I went mountain biking, and it was kind of great and this morning in the hotel, you know that there's really bright lights in the bathroom, and I kind of felt like I looked overly tan. Like I maybe just came off the golf course or something. So because I'm feeling overly tan, which is not a spray tan. It's legit. It's not orange. So in the spirit of talking about China, I got this shirt on Amazon. Look, does it look okay, great. It looks great. Okay, so, you know, everything on Amazon, not everything. A lot of things on Amazon come from China.
I know that, yes.
And while we were in lockdown, I said, well, I really need a button down shirt, and something that will show off my tan, obviously very bright white.
Had to get it on Amazon.
I had to get it on Amazon. So that's a little intro into our podcast today but it is kind of a serious topic. China has been in the news lately. So Xi Jinping has the leader of the Communist Party of China. Because in China, they have a sort of one party system. They're able to pass sweeping laws pretty quickly and sometimes they feel pretty heavy handed, and lately in the news, there's been a lot of regulation about that has been pushed down in China. And it's made global news. And it just feels like a lot has changed over there, and I think that the news we're hearing here is that it's very heavy handed, and that it could possibly be sort of a return to some of the communist practices. And, you know, regulation here, It's a four letter political word, right?
Yes, absolutely.
So American politics is, a lot of it's centered around cutting through regulation with a machete, and then when regulation gets kind of gets pushed down, then it kind of makes big news. The other part about regulation is it kind of tends to have unintended consequences. So first of all, I think it's politically unpopular, particularly for, you know, economies that operate in a very free fashion like the United States, then secondly, there's often unintended consequences and in China, they have a one party system, they can have heavy handed regulation all pushed down at once, and it feels a little bit scary.
So we're gonna talk about that.
Yeah, I look forward to seeing what Andy has to say about it.
Yeah. Andy, to remind everybody, Andy was on earlier with a podcast and if you didn't get to listen to that, that's the first China podcast that we did.
Did you like that one?
Yeah, that was great.
I think that has been, I've gotten a lot of comments on that podcast, being one of the most interesting ones we've done so far, not to take away from other topics, but that Andy is a resource on China, he's with Matthews Asia Funds, and he's their China expert. And, so he's going to hopefully deconstruct what's actually happening in China. And as you know, I kind of get annoyed at sound bite type journalism, and I'd like to dig into things I like to deconstruct what's really going on. So a lot going on in China heavy handed regulation, what is what it feels like, pushed down from the top very quickly, and that sort of has spooked investors a little bit and it has had some unintended consequences in the economy. So is this a move towards more communist type regime type outcomes? Or is this just normal businesses normal for China? Then for investors, this is what I want you to ponder as you listen to this. Is this a setup for a classic contrarian play where you have a whole region, you know, China being a very big part of the world's economy, being sort of shunned a little bit in the investor space? Is that a classic contrarian play? Because obviously, they're still a global growth engine. Or is it a value trap? So we're going to explore that in this podcast. So ladies and gentlemen, Andy Rothman and enjoy the podcast.
Andy, welcome back to the podcast. I really appreciate you being here for the second time.
Thanks. I'm looking forward to another conversation.
For the listeners that have followed this podcast, Andy Rothman was the first interview we did several months ago here on Deconstructing Alpha and we covered the subject of China pretty extensively in that interview. China lately has really bubbled up in the news again. And there's lots of subjects that we could be talking about with China, and hopefully we can cover an update here with Andy. Before we get started, though, Andy, will you remind our listeners what your role is at Matthews Asia and provide a little background?
Sure, happy to do that. So I'm the investment strategist at Matthews Asia and Matthews Asia is the largest, dedicated Asia active investment manager in the United States, we've got a suite of mutual funds and other tailored products for investors. I'm the one macro person on our 40% investment team that, as I said, just looks at Asia and about a third of our AUM is in China so that's a big part of our focus. I've been with Matthews Asia, which is headquartered in San Francisco for about seven years now. Before that, I lived and worked in China for more than 20 years, I was the China strategist for the sell side research firm CLSA, based in Shanghai. And I also spent 17 years in the US State Department as an American diplomat, working in Guangzhou, Hong Kong, and my last job was as head of the macroeconomics and domestic policy office, at the US Embassy in Beijing. I
really am honored to have you on here. And I hope to do this podcast justice, to answer some questions here that investors might have about China. Again I'm just so appreciative that we can have such resources as yourself. And what I think listeners got a lot out of the first podcast we did was that, you know, in this day of information overload, we've got internet, we've got sound bites, and we've got little snippets on TV, and it's really hard to get the real story or some sort of inside reality check on what's really happening in China. All we kind of hear is buzzwords or editorials or short little snippets. So I am just grateful to have you here because I feel like you really are the one person that really knows China. So in your role there at Matthews I'm sure you're fielding a lot of questions about China right now.
Oh, yeah. I feel like I'm living on Zoom calls these
days. Yeah, I think we're all probably doing a lot of zoom these days. So while you do cover macroeconomic topics all across Asia, China's obviously the large just portion of Asia, and really is, one of the growth engines of the world and there has been a lot of news lately about China bubbling up again. And so what are the most popular questions you're getting about China? What are people asking you
these days? I think the three most common questions I'm getting from investors are first, what is happening in with the regulatory crackdown in China? What does this mean for the future of the Chinese economy? For Chinese private companies and for the Investability of China? And then the second most common question is, what's going on with this property company called Evergrande? And should really be worried about that? And then third, what's happening with US China relations? And are the rising political tensions between Washington and Beijing going to have an impact on investment strategies and the investment environment?
Those are probably the three that I would ask you. So let's talk about those. So let's start with regulatory. So what is to quick synopsis of the regulatory situation? And then, so what I hear about the regulatory issue is, China is moving back towards being socialist, more communist more controlling more state government controlling type nation, all of a sudden, out of the blue, it feels like there's all of these changes that feel more socialist. What is your take on what's happening there? And is the common sort of interpretation of the actions that are going on the regulatory side? Is the common interpretation of that accurate?
Yeah, well, the way I'd explain this is there seem to be two schools of thought here in the US about what Xi Jinping, the head of the Chinese Communist Party, the Chinese government is up to the first school is arguing kind of what you were laying out there that Xi Jinping is trying to roll back the role of the private sector and entrepreneurs in the Chinese economy. Some people even go so far as to say that he's trying to take China back to where it was under metradome.
I just read a Wall Street Journal editorial, and I had to remind myself, this is an editorial. Not journalism is a little bit different about that basics that had that basic tenant to it.
Yeah. I strongly disagree with that school of thought, and don't think that it reflects what's actually happening in China, or what anybody in the Chinese leadership's thinking about. Let's just look at the reality on the ground in China. It is an incredibly entrepreneurial market driven place. It's got some really innovative, privately run companies. And this is an enormous change in just the last few decades. So I first went to China in 1980 as a student, I went back to work there as a very junior American diplomat in 1984 in the south and Guangzhou, back then there were no private companies at all. Right, I think we talked about this on the last podcast, you couldn't even find a privately run restaurant today, just a few decades later, including 10 years under Xi Jinping, the private sector drives the economy, it's more than two thirds of GDP, almost 90% of employment in urban China is in small, entrepreneurial private companies, all of the net new job creation, because the state sector is shrinking all of the innovation, all of the wealth creation, this has been what has kept the Communist Party of China in power so long, so they would have to be amazingly stupid to say, you know, we're gonna trash all that that's brought us here, and we're gonna go back to the old ways when we were before and, nobody cared about us. So that would be incredibly stupid for a regime that has been incredibly pragmatic, and not ideological when it comes to economic policy over the last three decades. And also, I'm just seeing no signs of that. So the effects Xi Jinping, the other day said, he wants to create more opportunities for more people to get rich. You don't have to believe him. It's a politician talking. But like I said, if you look at the facts on the ground, this is what's driving the economy. So the second school of thought on what's happening today is that, and this is my school of thought. Xi Jinping is worried about the same socio economic issues that we're worried about here in the US. Income inequality, wealth inequality, unequal access to health care, to education, anti competitive practices by large firms that inhibit the growth of small competitors, large tech companies monetizing consumer data without getting their permission, all these kinds of things. And I think Xi Jinping has been looking at what's happened here, let's say dating back to the 70s where we've been talking about these issues wrestling with them. In most cases, we haven't made a lot of progress with them. We just keep talking about it, and it's resulted in a lot of social polarization, which has led to political polarization, which has meant that our democracy has really struggled to try and deal with and solve these problems. And I think he's saying, wow, you know, let's get out in front of this. And he runs a one party authoritarian regime. So he's able to move really quickly, where we've struggled to move at all. And moving quickly means a lot of uncertainty, a lot of volatility, mistakes get made. But I think the overall goals and objectives are not to take China back to the Mao era. And we also have to remember, this is not new for China, they have always been a more state interventionist, capitalist model than we have more like a European version of capitalism than an American version of capitalism. And this is not new. It just maybe a lot of people aren't aware of this. But for example, the federal minimum wage in the US has been increased in over a decade, in the 2000s. during that decade in China, the government raise the minimum wage by at least 10%, every year for decades, saying, effectively two manufacturing firms, you know, if you can't pay your workers a decent wage so that they can drive the domestic demand consumption story, so that they can be happy with us running the country, then we don't need your jobs.
And it keeps them more competitive.
I think that if they pull this off, they'll have a better economic and social environment for companies. And there are going to be mistakes along the way and the second topic I wanted to talk about next year will be one of those mistakes with Evergrande. But you know, so there's volatility. We're seeing power shortages right now. But this is a result of the government saying we really want to improve mine safety, we want to reduce corruption in the coal industry, we want to reduce carbon emissions, and we want to improve energy efficiency. But they kind of went about it in a too fast, too hard way. And so there's some power shortages. But as an investor, you can step back and say, Okay, this might create a good environment down the road, how will these regulations intersect with the business model, so the companies that I invest in today are might invest in tomorrow? What impact will that have on their business models on their margins? And therefore, what's the right valuation for that company? Right, and this is why, and I acknowledge I'm selling my own book here at Matthews, Asia is an active manager, this is my active manager, it's really important to China to be able to look and do deep dives into the business model to each one of these companies.
Well, you know, we're big believers in active management over here. So I like to say I don't want MSCI to define how I invest, and certainly for a dynamic and changing environment like China. So the regulations to sum that up, it sounds like the intention of the regulation, whether it actually turns out this way or not, can be debated. But the intention of the regulations it sounds like are, we want a stable environment that is fair for all participants in our economy. And we're going to try to support private business by limiting big businesses, you know, anti competitive practices.
That's right. But it's not anti big business, and it's not anti people getting rich. Maybe they feel like if they have lots more millionaires that would be better than if they have lots more billionaires. And so that should this be scary to us? I don't know. It's kind of like the question. Would Jamie Dimon work less hard if he only made 10 million a year instead of 30 million a year. And one of the things that's become really clear is once the Communist Party in the 90s, backed away from trying to micromanage Chinese people's lives all day, every day, they have proven to be an incredibly entrepreneurial and innovative population.
Yeah, I was reading your piece on innovation in China and the power of technology as part of the growth engine of China and how they have a similar it sounds like a similar ability to formulate technology companies and build out new ideas at a rapid pace like the US and it's been highly competitive. And a large growth engine over there in China is the technology component, the innovation component.
Yeah. So there's no doubt that there will be stumbles along the way there always have been in China in the last couple of decades. It's not a smooth path. But I think that focusing on where those stumbles and obstacles will be which companies will thrive is a more productive way of looking at this thing saying, Ah, it's all over and shadow, we got to go away.
There's always unintended consequences. And when there's unintended consequences from government decisions, there tends to be pretty heated debate about it. You know, we all know that businesses can try to do things that don't quite work out, but they don't become the center of some huge heated debate. Certainly, when the government has what appear to be heavy handed actions, there's always consequences. And often when you do too much at once, it's kind of a problem. You know, sometimes it takes a little patience, like one step at a time. But the overall, you know, for the regulations, from what I understand of them, it sounds like in support a small business, making sure data and security and personal security and privacy is important. promoting healthy competition. Those three factors are the same points that are being debated right now in Europe. They're really no different, right? I think when they make grand, sweeping, quick decisions, it feels abrupt, but it's probably been years in the making,
I think it's also important for us to understand the mindset of entrepreneurs in China. Whereas here, kind of we become entrepreneurs with the idea that the government should just get out of our way. And leave us alone. And anything that the government does is likely to be perceived as negative. But in China, all of these entrepreneurs have grown up in a system where the state intervenes much more than they do here. And they're used
to that. Yeah, it's been 30 years of intervening here and there. And, it does tend to come in lumps, at least, from what I've noticed. It's not like steady changes coming down from the government. It's sort of like hands off for quite a few years. And then we need to do this.
Yeah. And I think for two reasons. One is that because things are so new in China, and their approach to regulation has been different than ours, it's often been, hey, new industries bubbling up, go at it. And we'll take a look at in a couple years, we're going to come back and tell you what's working and what's not working, what's too risky, and will regulate. So for example, a number of years ago, a lot of us got very nervous about what was happening in the shadow banking space, off balance sheet. And it was going crazy. But the government heard this saw this. And now for more than three years, I think 39 consecutive months, the year over year change in off balance sheet, loans outstanding in the financial system have been negative every month, for 39 months. So they're basically shut that down, shut down p2p, so it's just a different approach of regulating it after it gets going rather than beforehand. And then the other thing is, every five years, they have a party congress, this is a big political meeting. The next one is coming up next fall. And they often want to get a lot of stuff out of the way before that party congress starts. So I think that's one of the reasons why we've seen recently, a lot of new regulations coming down the pike so that it'll all be they hope, smoothly implemented on your way before the party congress next fall.
Okay, so regulation is kind of a normal thing in China, not something to be terrified about. So how does that connect to Evergrande? And what we're hearing in the news about evergreen?
Evergrande is a property developer. It's big, but not that big. It has four or 5% market share of the residential property market in China, new home construction. So let's put that in context to start with. The reason that Evergrande is in trouble today is because the Chinese government with regulations, tipped it over the edge deliberately. This is a company that I think has been well known, recognized for many years as poorly managed, high risk taking. And the government knew this. So about a year ago, they put a couple of three regulations in place designed to stress property developers who were overly indebted, and therefore presented in the government's view risks. And over the course of the last year, these regulations have come to bear on the company, and they are now in a liquidity crisis. But it's not shocking if anybody's been following this. And it's really the result of those rules. This is also not a Lehman moment, as some people have been
There's my next point, is this the Lehman moment, because I can't believe I've read that in the press or in the sound bites. And in my, immediate reaction, whenever they say something like that lightning doesn't strike twice. It's never the same thing twice.
The circumstances are just completely different. This is, as I said, a property developer, it is not a systemically important financial institution. It's not a market maker for treasuries. So it's just, you know, not even close to that. It's a real estate developer. The other thing is that you're not gonna have in China, any of the conditions that created our financial crisis. Because if you go back and look at what happened for us, it was a loss of faith among related parties. But in China, all of the major financial institutions controlled by the state. So everybody knows that the state is there. And then also with Lehman, the US government, including the Fed said, we don't have the legal power to do anything about this. Now, we can debate whether that was true or not looking back at what they did with other organizations like long term capital management, but that was what they said, and they allowed that to happen in China, the Chinese government's made clear that it has the tools and the political will to use those tools to prevent Evergrande liquidity problem from advancing into an insolvency problem. So they're well at work already, creating an orderly restructuring of the company. Now, it's not a bailout, because the owners of the company, including the equity holders, the bondholders aren't going to feel pain, they're going to take a significant haircut. But the government's focus is on two other groups, individual Chinese families that put deposits down on new homes, the government's main focus is making sure that other sound developers take over those construction projects across the country finish and deliver those projects to the people who paid for it. The second important group, they're going to protect our retail investors in China who bought wealth management products sponsored by evergreen, they're I'm sure going to get their principal back, because they don't want the social unrest and the spillover effects that would come from not protecting those two groups of people.
So not a contagion in and the government can act extremely quickly here, because there's really nothing in between, but in a free market environment, Companies can fail. And this is a we just we just talked about the you know, the difference between a completely free market environment, some regulations, and then certainly the third element here is, you know, companies get bailed out all the time now.
Yeah. And it's actually a really good thing, because what the Chinese government is saying is, investors need to price risk. And not all companies are the same. And actually, I would say, the semantics are important, they're not bailing out the company, the chairman of the company, is going to take a massive hit to his wealth. And investors in their bonds, who didn't do enough due diligence are going to take a hit. So this should be a warning to everybody in the business ecosystem in China that you need to pay attention to risks to price risks. And that's good. And also keep in mind, this is not new for China, either. We tend to sometimes have short memories, when stuff happens in China, we get all excited about it, then we move on to the next one. Hardly anybody is remembering that just a few years ago, two companies much bigger than Evergrande went under right Onbomb, HMA. Nobody remembers that anymore. And everybody was worried about what that would mean to Chinese economy. But now we don't even talk about it anymore.
Right. So I think, there's so many connotations about China, there's so many images and opinions people conjure up in their heads about what it might be really like there. Right. And I think just a few years ago, we we had all this hoopla about the ghost cities, right? And I think that kind of scarred people, right? They kind of thought there must be this huge explosion of real estate in China and they're just building stuff for no reason. And for some, somewhere in the future, this will all fail. Right? And but when I read about the Chinese residential real estate market, it is a very robust market and it it doesn't have nearly the risks people think it has.
Yeah, the whole ghost cities story is The ghost cities myth, as I refer to it is just doesn't go away and comes back all the time. But yeah, the property market is healthy and resilient in China. through August, the latest data we have your year over year sales on a square meter basis, we're actually up 17%. Now, the last couple months have been terrible, because the government has put the brakes on the market, but they do this periodically. And they'll lift the brakes after a while and it will come back again. New home prices through August were up 4%. Year over year, a year ago, they were up 5%. So a little bit cooler, but still decent. And in terms of a bubble in the property market in China, I'll actually let's finish on the ghost cities thing first, you know, you'll read in the newspaper all the time, people saying well, there's 50 million vacant or empty flats in China. Well, think about this. Chinese people are still buying lots of apartments, the price is still going up, although more slowly in general than income growth. They're putting down massive amounts of cash to get these apartments. But they're doing this even though there's 50 million vacant apartments across the country. So you'd have to assume that Chinese families are just really dumb. Why would they be buying more flats when we know from surveys that 80% of the flats are being sold to families as their primary residence? And in terms of bubbles, for me, bubbles are all about leverage. For example, Where did our housing finance crisis come from a decade ago, I think the ones statistic that illustrates that point is in 2006. In the US the median, cash down payment for a new home, the median was 2% of the purchase price. In China, the minimum cash downpayment allowed under regulation is 20%. And I have yet to find a bank that will accept less than 30% cash down, if it's going to be your primary residence. If you're buying up property for an investment purpose, it's hard to get a mortgage in China and usually have to put 60 to 70% cash down.
So it's not nearly as much of a leveraged market.
That's right. And on top of that, there's very little mortgage securitization in China. So banks, generally issue all the mortgages, and they have a lot of incentive to do good due diligence, because they're going to be holding the loan to maturity.
Right, That makes a huge difference. I mean, if you're going to write a loan that you know, you're immediately going to sell, all you're really concerned about is can I sell it, as opposed to Can I live with it? And I can tell you, I had three mortgages when I lived in China and the due diligence process, there was much more invasive than it has been when I've had a mortgage in the United States.
All right, well, that gets to my final question. So when we look at the world, most investors are dividing their portfolios up between stocks and bonds, and their stocks are split between domestic and international. And a lot of investors are definitely putting more money in the US because they live in the US than they are internationally. But when they break the international up, they're still breaking it up sort of by market cap, where Europe in first world nations, I guess, or, you know, Europe, Japan, Australia, New Zealand, Canada, probably getting more of the percentage of assets than emerging markets. And yet China is bordering on an economy, the size of Europe as a whole. And historically, China has been growing faster. And on multiple fronts and multiple metrics, China has just been growing much faster than, say something like Europe or first world developed, kind of nation. And so is the growth engine still alive in China? And are investors allocating appropriately their sort of international dollars? I mean, that's kind of a complicated question. But it's a it's a twofer. So I guess the whole reason to invest in China is you want growth out of it? Is the growth engine still alive?
Yeah, so from a macro perspective, it is definitely still thriving in the in the 10 years through 2019. So before COVID, China accounted for about 1/3 of global economic growth every year on average. That's a larger share of global growth then from the US, Europe and Japan combined.
last year, of course, because of COVID. China got it under control more rapidly than other countries, China have probably accounted for almost all of global growth. We're still waiting for the final data this year. In the coming years. It's probably going to go back to being just About 1/3 of global growth. So as I said, more growth than from the US, Europe and Japan combined. So when you're putting a portfolio together, whether it's for your retirement for your grandkids, education, that's something to think about, do you have exposure to that now, clearly, also, it's a driver of innovation in many areas. But I also recognize it's not easy. There are a lot of bad companies in China. And it's hard, the language is different, it's far away. But this is, again, why we advocate an active approach, because we're the largest dedicated active China manager in the US, but we only own shares and just over 200 companies. So that's about 4% of the listed universe, we can be really, really picky on behalf of our clients. And, you know, I know a lot of people are worried that political tensions between Washington and Beijing are seeming to get a little bit hotter, which is not good. But it's also important to remember that this has been going on for a while that despite the talk of a trade war, and the tariffs, Chinese economy has thrived. And it has continued to rebalance away from traditional heavy manufacturing away from exports. This is the 10th consecutive year in which the tertiary part of Chinese GDP, that's the services and consumer part is the biggest part. So it is increasingly a domestic demand driven economy just like you're in the US. And that's why if you look at how our China focused strategies of Matthews operate, a heavy focus on Chinese companies selling goods and services to Chinese consumers.
Right. And that's another thing I think that is misunderstood about China is that I think the world thinks China's dependent on us to buy all their goods, which we certainly are huge net importers of goods produced in China and as is Europe. But their economy exists and thrives on its own. And and all the profits are in the service base side, right? I mean, manufacturing is a low profit type operation, where services is high profit and services are generally domestic. So China can survive and do well, even with some of these tariffs and things in place.
More and more than survive. I mean, I think the tariffs have been incredibly misguided, as US government policy, because in the end, it's really clear that those tariffs are being paid by American companies and consumers, not by Chinese. Last year, for example, the share of total US imports that came from China, actually went back up to tie the all time high level, despite the tariffs,
yeah, despite the tariffs and despite price increases.
That's right. So we've been paying those pipes increases, not Chinese companies. And I'm disappointed to see that we haven't moved away from that this year. Yeah, it's more of a drag, I'm afraid on our economy than it is on the Chinese economy. And in terms of, you know, the biggest employer, the biggest driver of new job growth, biggest driver of new innovative companies. It is all in the consumer services space, which is driven by domestic demand.
So I guess to sum that up, China still sounds like a growth engine, it does seem like that a lot of the growth is coming from two areas of the world. US and China. And , I would guess it was pretty doubtful that anybody would have 1/3 of their portfolio in the US invested in China, not many people would, right. And so with China making up 1/3 of global growth, and an economy that is domestically driven, to the degree it is that investors might be
underrepresented. And I'm certainly not going to argue that the average investor should have a third of his portfolio in China, of course, but it's important to to look at whether you have an adequate exposure, that driver of global growth. But the other important thing, I think, is that what happens in the Chinese economy has a huge impact on our economy. And when you have maybe 5% of your portfolio, in China, that forces you to pay a lot more attention to what's happening in China and going beyond. You know the headlines in the Wall Street Journal, so that you better understand what's happening there, which will, I think make you a smarter investor in the United States because remember, You know, the Fed is always watching China. And GM sells more cars in China than it does in the United States. Qualcomm gets two thirds of its global revenue from China. So understanding that having a stake in that just really focuses the mind a little bit more I think.
Yeah. And if the political tensions spiral out of control, it doesn't necessarily hurt China, it hurts both of us. And, so it serves us both to not necessarily out escalate all of these tensions. And I think the other part of it is that it sounds like there's a misunderstanding about the potential of China the quality of the businesses in China, and the term that the under investment in people's portfolios in China may maybe that creates an opportunity for investors, maybe this is the sort of classic contrarian situation that investors look for. So, alright, um, we're probably butting up against, I tried to make this podcast Andy, I tried to make it 30 minutes. So I don't think I did that. But every time we start talking, this is just such a great subject. So every time I start talking about it, I talk too much about it. So let's leave with this. Okay, so is there anything you would like to leave us with here about risks for China or opportunities for China?
I think when talking about risks and opportunities, the main thing is not to get too carried away in either direction. Because often, I hear people either say, China is going to take over the world, its economy is growing so fast, it's going to leave the US in the in the dust, or China is going to collapse next Tuesday at
three o'clock. When the Chinese when the Communist Party takes over, right? Yeah.
And sometimes the same people say both of those things on alternate months. Yeah. It's, it's gonna be something in the middle. China has been unconventional, for the last few decades, as it's been trying to make its way in its form of capitalism, which is not our form, for sure. But they've done a really good job, the growth in China, the change and standard of living for, for most Chinese people has just been phenomenal, just as a period of time that I've been doing. So having a balanced, well thought out, understanding of what's happening in that country is a really useful thing for all investors, regardless of whether you're investing directly to China or not.
All right, Andy, great subject. Obviously, timely bubbling up in the news, all of this news about Evergrande and regulations, and is China going to hit its growth targets and all that, and how investors should see and think about this information. I so very much appreciate you taking the time to give sort of real insight, insight based on experience and decade's worth of interactions with China. And I just so appreciate this. I really thank you for being on here. And I do have to end it, because we'll go on forever. So I'll just have to have you back again, if you if you'll have me.
So I enjoyed the conversation again. And also, let me just plug that I write about these things on a fairly regular basis under the sonology title, and that's available on the Matthews Asia website for all to read if they're interested.
And I do read them and for those you said that pretty quickly
just go to the Matthews Asia comm website and look under I think it's called the the insights tab. You'll see it.
Yeah. Thanks, Andy. I really appreciate it. And we'll hopefully talk soon.
Okay, appreciate it.
Thank you. Bye
let's give Scott Iverson a shout out for that jingle.
I just, I just love that jingle. And then hopefully we'll introduce some of these other investments themed songs here. And for those of you who don't know, Scott Iverson, Scott Iverson works for frontier asset management, and he was a college football star. And he's
one of the nicest guys you'll ever meet. Yeah, he's a he's
just a big bear.
Yes, he is. Well, I think that was another great interview with Andy. He just has so much knowledge about China, and we just really appreciate him, you know, taking the time to
Oh, I just so appreciate that relationship. And, you know, I don't know where else you would find a resource like that on China?
Yeah. Yep. So to start today, let's talk about the minimum wage. I thought it was, you know, really interesting that he talked about China raising, you know, 10%, every year for a whole decade in the 2000s. But the United States hasn't raised their minimum wage in over a decade.
So I mean, here in the United States, we haven't technically raised the minimum wage, but the marketplace has definitely raised the minimum wage. I mean, with the worker shortages were having and all that, I mean, everybody's wages are quickly rising at the, at the bottom level, there are rising pretty quickly, people who are on the hourly level, but over in China, you know, that they have this, the the edict that's that is at least talked about by the Chinese Communist Party, is what they call common prosperity. And that if they're going to be an open, entrepreneurial, you know, capitalist type culture that it needs to benefit all people, right. And so they, which I guess is kind of a socialist angle to capitalism, right. And so common prosperity is that the businesses need to benefit all people. And so I guess that, then continuously, raising minimum wage over there and worker standards is really just part of that common prosperity edict. So what people have sort of mentioned here is that we have a little bit of shareholder primacy. And what that means is that business owners and shareholders sort of, they sort of have primary claim on the earnings. And wherein in China, they have, you know, in theory, if you have this common prosperity thing, and you have to take care of the workers and all that stuff, then you have less of that shareholder primacy and so that, you know, that in terms of investing sense, would cause you know, those businesses to have less profit margin.
Andy mentioned that every five years, the China has a party congress. Do you know anything about the party congress that he was talking about? I haven't heard that.
You have stumped me. He did, I guess talk about the party congress. And I think that's why we have Andy Rothman on the podcast. Because he knows more about that.
And ask him about that next time.
Yeah, yeah. So there you go. I don't have an answer. All right.
But that was my one goal today is to stump you. Good job. Awesome. Well, can you explain on the Evergrande and liquidity crisis? That seems like a hot topic in the news?
So Evergrande is a big real estate development company over there, I think is the large Did you say it was the largest real estate developer, in China, and Evergrande made big news when they defaulted on their debt. And it felt in a marketplace like a Lehman moment, like, as we've all have seen these pictures of the ghost cities, and we all kind of from the outside, it looks like there's just this housing and construction boom, constantly in China. And it's easy to look at that and go, we'll pay in for that. Right. And, and there must be so much debt outstanding. And but Evergrande, as Andy said, you know, his has been sort of a not, you know, it's been pretty obvious that they have been the one company in the real estate space that that is, has been in debt a long time and then debt and has very aggressive debt practices. And sooner or later, some of those companies just fail.
Alright, and it seems like they kind of targeted it. Yeah,
I think the government probably said, Look, this is just too much. You just can't get away with this for too long. And we're just going to buy they must have known by changing the debt rules, that that, that they would be a victim of that.
Yeah. I thought it was interesting, though, you know, because it's such a big thing in the news and everywhere, but they only have four to 5% of the market share. Yeah, that that was, yeah, interesting.
Well, I just think it would be I mean, I think if we looked at all the statistics, it would just blow our mind what over a billion people need, yeah, what they need. And so they're, you know, they talk about all these, you know, I don't know, 17 different cities with more than 5 million people in them and things like that. There's just a lot of construction.
Yeah, yeah. Yeah, that kind of goes into my next topic. Um, Something that just completely blew my mind. He said that people in China put 60 to 70% cash down on purchasing a home. Yeah. How is that possible?
Well, I know how is it
possible they live with their parents still or 40?
I don't know. But like, I was also blown away by the lending standards and how difficult it is to actually get a mortgage. And that, you know, so the actual buyers of the real estate are not, you know, they're not the going to, you know, what, what, Andy's basically saying they're not going to be the victims here. Right. And so the dad is held, you know, by the business by the businesses that are doing all the construction, but not that consumers. And, that they're very careful and frugal about how they buy property in theory, because they have such a difficult mortgage standards.
Yeah, that's the one thing that I noted is that Andy said, he sees most banks allow for a minimum of 30% down, which is such a stark difference than the United States.
Oh, yeah. And, you would think that those cities, I mean, I'm sure there's rural areas in China, just like anywhere else in the world that are is not expensive. But I would imagine that those cities are really expensive, because there's so much demand for people to live in those cities. That's obviously like anywhere else in the world. That's where a lot of the jobs are and everything. Yeah,
So to wrap up our time today, I think we just need to go back and mention again, like we did the first time. And he makes it sound like there are some useful benefits that can come from active management. Yeah,
I think so. I think when you're going into a marketplace, like China that is so different than other countries than actual local knowledge, actual, which businesses you buy. And then clearly how a government can just change a whole industry, you would want some local knowledge in terms of your stock selection, you wouldn't want to just own it very helpful. Yeah, I don't think you'd want to own every company in China. And so, yes, I like many other areas of the world. I think there are advantages to active management. There's also you know, not to discount indexing. We also, you know, buy some indexes here and there, but I think I personally am in favor of active management in a place like China.
Absolutely. All right. Another great conversation.
This is fun. Shannen,
thank you so much. Please stay tuned for our disclosures.
Thank you, and thank you, everybody for listening. Appreciate it.
This podcast is for informational purposes only. The information does not constitute advice, or a recommendation of any specific investment mutual fund or mutual fund company. Before making any investment you should carefully seek independent legal, tax and regulatory advice. In particular, you should seek the advice of a licensed financial advisor regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation, any particular needs, and your ability to assume the risk and fees involved before investing. This podcast and presentation are for informational purposes only. Frontier assumes no liability for any action taken in response to listening to this podcast. Frontier Asset Management is not affiliated with any specific Fund Company. The views and opinions expressed by each speaker are their own as of the date of the recording, any such views are subject to change at any time, based upon market and other conditions and Frontier disclaims any responsibility to update such views.