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Xi Rules, China’s Prospects Darken

Pebble

Friday's other big news was out of China.

​A supposed copy of a report about US audits of Chinese based companies combined with the fourth (fourteenth?) rumored reopening and move away from "Zero Dynamic Covid" policies sent Chinese assets skyward.

We should point out that nothing has formally changed yet and we have seen multiple false dawns before. The threat of a US ruling against Chinese-based companies' accounting practices and the actual existence of the Covid program have been hanging over Chinese markets for quite literally years.

​All of this notched a trillion dollar gain in Chinese stocks for the week which demonstrates both the level of hope and what might be possible in any sort of real "turn" in the Middle Kingdom's fortunes.

But we would like to caution our readers that as decoupling between the Chinese and American economies continues and the political rivalry deepens, we remain very wary of Chinese companies and financial products.

The reason isn't so much economic as it is political.

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Earlier, we wrote about the UK's teetering on the brink of an epic financial collapse and how investors were revolting and imposing a fierce discipline upon both the country as well as its ruling Conservative Party because of its fiscal indiscipline and amateur political behavior.

We suggested that while the British experience had been both volatile and dramatic it would likely not be alone and so would bear thinking about as other countries regrettably find out that there can be very real consequences if they act foolishly

Little did we know that, just as we published our newsletter on Sunday evening, investors were already noisily voting with their dollars once again on the other side of the world.

That very Sunday, the Chinese C​ommunist Party was holding the final day of its 20th Party Congress where a lot of important matters of state would be decided and, more significantly, announced to the world.

The big announcement had been foreshadowed for months if not years: Xi Jinping has been reappointed for an unprecedented 3rd term as President and CCP General Secretary.​

But wait, there is more!

The highlights include:

In China, the future is still male, concentrated around one figure and any sort of disagreement is not to be tolerated.

Perhaps most shockingly of all was a casual display of naked power politics at the very end of the Congress:

This was, in real time, a holy sh*t moment.

Hu Jintao was previously in President Xi's position and leads a powerful faction in the Communist Party. This was a demonstration of power that you typically only associate with the Game of Thrones type of television drama or something you might read about in a medieval court.

The video is chilling and worth a watch:

The big consequence of this was - despite much of it had been expected for months - Chinese markets sold off heavily on Monday (so overnight Sunday for the US).

Apparently investors in Chinese markets didn't like the fact that the marketplace for ideas was no longer tolerated.

Here are the details:

This was abrupt and dramatic but all it really did was accelerate a relatively long running trend.

China has been trending in a bad direction for years now on various fronts: economic growth, political openness, freedom from interference, the rule of law etc.

Covid super charged these trends and added draconian lockdowns and a capricious testing regime to the mix.

But Xi Jinping taking over, installing his loyal cronies and demonstrating a callous and capricious use of his power was another nail in the coffin of the "China may not be perfect but is still a big opportunity" thesis, previously beloved in the halls of Davos and the Fortune 500 executive suite.

The consequences of this centralization and move towards autocracy are now coming clear: investors are voting with their dollars and their feet.

So far this month, the Chinese currency, the RMB, is at a 14 year low:

More notable still is the stunning fact that the MSCI China index has now recorded 0% since inception 30 years ago.

The Hang Seng Index has now fallen to a level not seen since 1997.

In other words, China watched the performance and results in Britain the last month or so and said "hold my beer."

The reason isn't very complicated. We have had years of Xi Jinping's rule at this point and it is very evident that when it comes between choosing a better performing economy or more political control he will choose the latter every time.

As we saw on Friday, Chinese equities may bounce over the short to medium term. There are plenty of reasons that, now that Xi Jinping feels more confident and in control he may stimulate the economy some, open China up more and. perhaps, just perhaps, move away from the brutal zero Covid policies that are doing far more than just damaging his economy.

But for a lot of investors it will never be enough. They have seen under the hood and possibly been burned and will never buy back in without significant political reform and possibly major political and revolutionary changes.

Nor should it.

One of the problems for investors is the fact that many EM indices or ETFs or mutual funds also have Chinese assets and possibly quite a bit of them. So, beware, you might be more exposed to more Chinese assets than you realize. Keep this in mind as you look at your 401k allocations at the end of the year.

But there are other, greater ailments plaguing China as well. The CCP has been autocratic and nasty forever and Xi Jinping has been slowly throttling the economy and society for well over a decade now.

But there are some structural and external challenges coming as well, especially around: how will the Chinese economy prosper in the year(s) ahead.

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