To put it out there, I am not smarter than Soros. There, I said the obvious.
But I believe that an average investor do not need to be as smart as Soros to make good money. He or she just need to make reasonable assumptions and proceed on that basis. Here, are my reasonable assumptions for the HK/Chinese stock market.
--- My thoughts ---
My thoughts are that it is impossible to predict the outcome with reasonable certainty as there are way too many moving parts and too many factors to consider.
However, I believe that an investor can proceed on certain reasonable assumptions, without trying to pass judgement on the outcome.
One, it is reasonable to assume that any restructuring will not be achieved in a straight line fashion, but rather in a stop-start fashion, where the Chinese have to decelerate growth to rein in bad credit and excessive capacity, while raising wages and boosting domestic consumption. And when growth undershoots and lead to the risk of a viscious downward cycle, it will have to tap on the accelerator, expand credit and boost growth. In essence, the only viable strategy is to grow both the export and domestic markets in parallel but in a fashion where the domestic market growth must outstrip the export market growth.
This however is tricky as 1) it assumes that the Chinese authorities are god-like and could manage that process with precision, 2) the external demand must be sufficiently strong to allow the Chinese export market to continue growing, 3) consumers must continue to feel optimistic about the future despite an environment of slower economic growth.
Implication #1. A stop-start growth pattern will most likely lead to similar volatility in the Chinese/HK stock market due to constant adjustment in the assessments & expectations of short-term & long-term economic and profit growth rates. This, in my view, will be profitable for those who are able to call the fickle shifts in expectations. But that is a risky business for most investors.
Two, China will most likely see lower growth rates in the immediate years and possibly after. The odds are stacked this way because 1) a maturing economy will natrually see lower growth rates, 2) its impossible to constantly grow at >8% p.a. And during the restructuring period, growth will most likely fall because the larger part of the economy (export/investment) will need to grow at a slower rate than the smaller part (consumption). Unless consumption demonstrate off the chart growth - and it is entirely possible though the odds are not in its favor - growth will natrually be lower.
Implication #2. The implications for investors is that valuations for stocks should come off in general as expectations of long term profit growth should be lowered. It means that even with profit growth, stock prices may come down due to valuation compression. Historical valuation range may be a poor yardstick for the investor in trying to predict forward valuations.
Three, the continued growth of China will not be shared by all. On average, the export businesses will see lower growth unless they successfully shift their production for domestic consumption, in the same way that the Chinese economy is restructuring. There will be consolidation & thus survival of the fittest.
Implication #3. The marginal player in the commoditized export business will die. The remaining will share the profit pie but it is unclear whether their slice of the profit pie will be larger than what they had previously. The performance will be relative rather than absolute. At some prices, such businesses may be attractive, but in most instances, one may find himself being too smart for his own good in trying to pick winners here because the winner may not even see profit growth.
Four, wages will have to increase for restructuring to succeed. Those who are unable to increase prices faster than wages or manage other non-wage costs to grow slower than wages will either see i) lower profit margins, ii) negative growth [it is possible to see higher growth even with lower profit margins, if revenue growth is sufficiently high]
Implication #4. Expect potentially slower revenue growth due to potentially slower economic growth in China, and expect potentially even slower profit growth due to rising costs. Three types of companies will buck the trend - i) those with strong brands [pricing power], ii) those with market power in a non-fragmented market [pricing power], iii) those with superb cost management skills [cost control]
Conclusion. It appears that there are many reasons to be short on the Chinese market, since even a successful restructuring seem to offer the possibility of stock price compression. Further, unlike the previous era where the rising tide of wealth creation lifts all boat, this change in tide will see winners & losers emerging. So the odds of picking a winning idea is now further reduced. The only prudent way to navigate through this treacherous ocean is to be a stock picker. One can also try to call the fickle shifts in waves as the tides move but that may be a lot harder.
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