Fourth Quarter 2015 Update
As we have mentioned before, we are patient investors in an asset class that is fundamentally long-term in nature. While we largely discount or ignore the noise that is inherent in today’s markets, we do pay attention to specific events that could signal a macro shift in economic conditions – situations that could take years to play out and thus give rise to both investment opportunities as well as sectors to be wary of.
One such shift has been the continued erosion of oil prices. Reasons for the drop are many, including the shale revolution in the US, and the potential lifting of sanctions against Iran. However, a major catalyst appears to be the ongoing slowdown in the growth of the Chinese economy. While lower oil prices generally tend to be positive for most economies, particularly those that are not commodity-driven, the impact of slowing growth rates in the world’s second-largest economy will likely be felt across many sectors and over an extended period of time.
China is going through a well-documented transition. There is new political leadership, there seems to be a focus on tamping down large-scale corruption at the higher levels of government and the state-owned enterprises, and the consumption economy is starting to emerge. However, there are still a number of major issues to be confronted – there has been significant over-investment in infrastructure and capital-intensive industries, the financial system is still largely driven from the top rather than letting market conditions dictate the allocation of resources, significant environmental pollution, weak enforcement of intellectual property rights – we could go on.
Dilip had the opportunity to visit Beijing earlier this month on a short and relatively packed business trip. Some observations, and like all such notes, please treat them as anecdotes:
- The weather cooperated to such an extent that the entire week was clear – blue skies, you could see mountains in the distance, no visibility issues. And nobody was walking around with face masks.
- Beijing is a fully-developed city on par with any other western metropolis, or Singapore or Hong Kong. It has the requisite glass-and-steel buildings, transportation infrastructure, neon (though in Chinese characters), etc. The roads, sidewalks, airport, etc. all appeared fairly new and were well-maintained.
- Traffic was largely well-behaved, though the roads were packed from early morning to late at night. Perhaps it’s different in the other Chinese cities and it’s certainly different in other Asian countries (India, for example).
- English is not widely spoken or understood but is more common among the younger generation and the business community.
- While social media is widely used, they are all Chinese equivalents – Baidu, Weibo, WeChat, etc. Google and its related properties are largely blocked in the country.
- The size and scale of the country becomes more apparent when you are in business meetings – for example, we had 3 participants from our side in one meeting while our counterparts brought over 20. And it was clear that they intended to deploy significantly more resources when it came to executing on the objectives.
- When motivated, they’re able to move fast. One of our colleagues is an advisor to a large state-owned enterprise, and he mentioned a recent project that he was a part of where the company spent over $200M – it took barely two weeks from the initial concept, getting approvals, and having equipment be deployed. And this was for a project that was not considered strategic.
- There’s a general push to climb up the value chain. Low-cost, high-volume manufacturing is no longer the primary goal – in fact, there’s now movement away from China to places like Vietnam and elsewhere for such activities. Across the board, there’s great interest in partnering to acquire technology, companies, and other capabilities such that China is able to design and build innovative products, or at least be on par with other global players. This may well be the eventual solution to the ongoing IP issues – when they realize they have as much to lose by not enforcing their own laws.
- The Chinese stock market triggered the circuit breaker on the low end on successive days during the visit. It was hard to tell if people cared. Either the capital markets are still an isolated part of people’s lives or we were tuned to the wrong TV channel.