Should you quit China stocks?

We can say that the recently concluded 20th National Congress was the straw that broke the camel's back - many of the popular China stocks were down double-digit percentages after the markets opened on Monday.

It was a way the markets were showing displeasure against Xi's third term. But Xi taking a third term has already been known long ago and would have already been priced in. Even his speech about how he would run China in the next five years was also made known a week ago. Markets didn't respond until now.

It could be that the markets did not like the new lineup for the Standing Committee, the core 7-man team that decides the fate of the entire China.

The media kept reporting that Xi has installed his gang members to the heart of the government and now have complete control of China. Let's explain a bit.

Although from the outside, the Chinese Communist Party (CCP) seems like a single party, it is further from the truth - it is rife with political rivalry as there were factions. Xi used to be from the Shanghai gang but has since created his very own Xi faction. He even purged his previous gang and reduced its influence over the years.

In the current Standing Committee, except for Wang Huning who has no faction, the rest were from Xi's faction. The rivaling Chinese Communist Youth League (CCYL) was entirely removed from the Standing Committee.

Li Keqiang, the outgoing premier, was from CCYL. As with Wang Yang, who was touted as his successor until he didn't. Sun Chunlan too, the highest ranking female politician in China, has retired.

The demise of the CCYL was epitomised by Hu Jintao's sudden exit during the final meeting. Hu was the former President of China and the symbol of CCYL. Was the exit deliberate - to televise to the whole China and beyond that no one should challenge Xi?

As usual, China doesn't disclose much. It is a high context culture and leaves a lot of room for everyone to interpret. The west is quick to fill in with their own narratives, often with an anti-China stance - the most extreme view was saying Xi is following Mao's footsteps, bringing China backwards.

That negative narratives probably spooked the markets and foreign funds were quick in withdrawing from the Chinese markets. Like it or not, the fund flows are still controlled by the West as their institutions hold trillions of dollars.

China investors aren't big equity investors as they love properties more. They can't help themselves now given that there is a meltdown in the property market in China.

Hence, there isn't any support for China stock prices to cushion the fall. The only buyers are probably the companies themselves doing share buybacks. But they can only do so much.

But why is a Xi-controlled China that bad?

Is it because there is no CCYL to check on Xi? The yin-yang balance is gone and Xi could unleash the full wrath of his policies and ideology?

His idea of "common prosperity" and zero-Covid policy have been disliked by investors.

Xi has blamed the 'irregular expansion of capital' - he doesn't want people to get rich merely by using capital but to put in good work that contributes to real development and the economy.

He has since curtailed the tech companies as well as the property market where capital were greedily deployed.

Especially so since he wants to catch up with the West in terms of technology, he needs to divert resources to productive work - not play Tencent games or buy stuff from Taobao live-streamers or speculate in the property market.

As for the zero-Covid policy, it is clear that it puts a heavy toll on the economy across the board.

Given so much bad news, what should investors do?

China has so much promise but the stock market has brought so much disappointment.

We don't need to suggest to those who don't buy China stocks or have sold China stocks. Only those who are holding China stocks are relevant to this discussion.

Even so, there are a few groups of hodlers.

The first group consists of investors who don't have confidence in the long-term growth of China. Some may even lament about how sucky their China stocks are and how China is doing everything wrong.

We believe this group should sell their China stocks. Why make yourself so unhappy? Health is more important. Sell, relieve the burden and move on.

The second group consists of investors who have short investment horizons. This group of investors has been holding China stocks for a while as they kept thinking a rebound is coming soon, only to be disappointed again and again.

Our thinking is that it is better NOT to hope for a quick rebound because it is the expectation that kills. Just sell and invest in something else that could make money faster.

And for older investors who really indeed have a shorter investing horizon, China stocks may not be suitable due to the longer timeframe needed for the issues to be sorted out, if ever. It is okay to hold if you are leaving the stocks for the next generation.

The third group consists of the long-term optimists of China. One of such optimists would be Charlie Munger. Here's a excerpt of the Daily Journal meeting in Jun 2022 when Munger was asked about investing in China,

"Becky Quick: In January Jeff Gundlach was quoted, “China is uninvestable, in my opinion at this point. I’ve never invested in China long or short. Why is that? I don’t trust the data. I don’t trust the relationship between the United States and China anymore. I think that investments in China could be confiscated. I think there’s a risk of that.” Obviously, with a significant percentage of the Daily Journal’s marketable securities invested in BYD and Alibaba, you feel differently. Please explain why you are right.

Charlie Munger: Well, of course, only the future knows who’s going to be right. But China is a big, modern nation. It’s got this huge population and this huge modernity that’s come in the last 30 years. And we invested some money in China because we could get more value in terms of the strength of the enterprise and the price of the security than we could get in the United States. Other people, including Sequoia, the leading venture capital firm in the United States, have made the same decision we have. But I’m sympathetic to Gundlach. If he’s nervous he doesn’t have to join us. Different folks have different opinions. I feel about Russia the way he feels about China. I don’t invest in Russia, so I can’t criticize the Gundlach’s point of view. It’s just I reached a different conclusion."

Bottomline, study and invest in what you believe in otherwise you would always be in a dilemma whether to hold or sell. Don't blindly follow someone else or merely invest in the hottest investment of the moment. When things go wrong, which they always do at some point in time, you would find yourself stuck and in doubt.

Everyone has a different opinion, find yours.

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