Are investors facing a Yukos moment in China?
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The writer is president of Queens’ College, Cambridge and an adviser to Allianz and Gramercy
The headaches for foreign investors in China have mounted. It is not just a matter of a strongly underperforming stock market and several corporate bonds trading at distressed prices.
Due to government actions during the past few months, there is also real concern about investability of the market. The question is wide open.
For emerging market investors in particular, is this the equivalent of a “Yukos moment” of almost 20 years ago which saw the Russian market reel in shock from the government seizure of the oil company before a rebound? Or is it the start of a secular Chinese realignment that will see westerners treated repeatedly as the equivalent of a high-risk junior tranche of a financial investment that is the first to be hit by any shock?
The numbers are stark. So far this year, the Shanghai and Hang Seng stock indices have underperformed the S&P by about 20 and 30 percentage points respectively. Bond investors have seen a notable number of Chinese corporate holdings fall sharply in price. And all this has taken place despite China being among the first economies to recover strongly from the 2020 Covid-related economic hit.
That recovery has now slowed and Covid-19 outbreaks are again disrupting activity. However, the main driver of the underperformance of Chinese assets has been government intervention to upend the operational and financial conditions for several sectors. Motivations range from the need to stop excessive debt and leverage to bringing rich tycoons to earth as part of the government’s new focus on “common prosperity”.
The resulting repricing of Chinese financial assets has gone through three stages: an initial sharp drop in the valuation of the targeted sector, then a more generalised repricing on concerns of spreading government intervention and, most recently, a modest yet notable relief rally as the interventions suddenly stopped. That upturn has also been spurred by the avoidance so far of a financial catastrophe triggered by the woes of property developer Evergrande.
For some investors, this is a golden opportunity — the sort of overshoot window that opens up occasionally in emerging markets and provides investors with ample multiyear returns. For others, it is the calm before yet another storm.
Choosing between these two competing hypotheses requires a difficult political assessment. It is reminiscent of a situation in Russia that investors in Yukos remember particularly painfully. At the time, the initial financial losses after the Russian government went after the oil company were significant. But Moscow’s disruptive government interventions subsequently slowed after President Vladimir Putin’s message to business was received loud and clear. What followed was a 25 per cent recovery in the Russia benchmark bond between the Yukos 2004 low and September 2005 and a nearly doubling in the stock market.
That is what dip-buyers are betting on in China. They believe that Beijing has gotten its point across and that the situation is reverting — maybe not as far as the prior paradigm in which the government was viewed as a reliable financial backstop but at least one in which its role is neutral.
But there is another interpretation with opposing investment implications — that government intervention will restart and roll into other sectors. It is part of a bigger realignment of the Chinese economic and financial system fuelled by both internal and external considerations.
Internally, it is about reasserting the authority of the state and restraining the power of the super-rich, both as a standalone objective and as part of the common prosperity drive.
Externally, it is about a generally less accommodating geopolitical operating environment, particularly as the administration of US president Joe Biden shows little interest in deviating from the more forceful posture towards Beijing. This is one of the very few issues that commands bipartisan support in the US Congress. In such a world, China feels that it needs to rely less on its economic and financial links with the west. Such partial decoupling becomes a priority for longer-term economic wellbeing.
I, for one, am unable to opt with confidence for one of these two competing views even though global relative valuations clearly favour Chinese assets. This does not mean abandoning Chinese investments altogether. But since we do not know if, when and how the next Chinese Yukos may be targeted, it calls for very cautious sizing, extremely careful company selection and constant geopolitical reassessments.
Unhedged — Markets, finance and strong opinion
Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday