Author Archives: viczhou

(Revised) China’s Stimulus Package for Growth

In the past few months, the market focus has been on the Federal Reserve’s exit strategy and the slowdown of China’s economic growth. Regarding the latter one, the world-second largest economy grew at 7.4% in the first quarter, a level significantly below the double-digit growth many years ago and the 7.7% growth last year.

Since the country has set a target of 7.5% economic expansion for 2014, the below-expectation performance triggered further concern about its growth momentum. In response to that, China’s State Council, the government’s executive body, unveiled a stimulus package in early April to boost growth, including additional spending on railways, upgraded housing for low-income households, and tax relief for small businesses.

Although the package is considered as a mini one compared to the four trillion yuan ($650 billion) program rolled out in late 2008 amid the global financial crisis, it would still impact its overall economy in many ways.

Stimulus 1: Additional Spending on Railways

The government would further develop infrastructure through accelerated railway construction, particularly in the nation’s central and western regions, and more aggressive financing. Some operations in the public interest would be subsidized and 150 billion yuan ($24.6 billion) in bonds would be offered by the government to finance construction for the railways. Relatively, the stock prices of companies in the railway sector rallied, as shares of China Railway Group surged 5.1% and China Railway Construction Corporation’s shares jumped 7.2%.

Personally, I think the spending will have a double-sided effect. Positively, tremendous infrastructure construction will boost growth effectively, and the emphasis on development in the central and western region will lead to more balanced economic landscape across the country. Negatively, as China is undergoing a significant transition from being overly dependent on investments and exports to relying more on domestic consumption, the massive government-led investment project might impede structural reform, and the increasing credit along with financing might pose additional risk in the credit market.

Stimulus 2: Upgraded Housing for Low-Income Households

The government would also spend more on slum clearance and upgrade of poorer urban areas. It added that the China Development Bank, a lender for key government policy projects, would set up a special arm to issue bonds to support new homes.

In my view, this measure could be a complement to the railway construction because of its focus on ordinary people’s well-being. It is a tradition that Chinese people care a lot about their housing and treat it as one of the most important measures of their living standard. If the housing upgrade can be implemented effectively, it could ease social instability and stimulate domestic consumption in the mid- to long-run.

Stimulus 3: Tax Relief for Small Businesses

The government would extend existing tax breaks to small businesses until the end of 2016 and raise the threshold for taxing smaller businesses, which have been struggling as economic growth slows.

I do believe that small businesses will benefit from decreasing tax burden, but this measure might not address their problem radically, which is largely due to the lack of financing. State-owned banks mainly offer loans to large, state-owned enterprises, putting small and medium businesses in a significant disadvantage in market competition. So in addition to regulating state-owned banks, the incorporation of private capital for lending and in-depth financial reform is also indispensable.

In conclusion, as the market force is set to play a fundamental role in the overall economy, it is the quality rather than the quantity of growth that should be strengthened. Therefore, the new leadership should be committed to structural reform with emphasis on wealth increases of ordinary people so as to unleash domestic consumption and underpin growth stability.

The Essence of Wealth Management

Wealth management is a lifelong task. Either you are an individual investor or a professional asset manager, the central goal is to steadily increase your wealth through proper management of capital. Personally, I think there are two keys to successful wealth management: diversification and customization.

Diversification for Capital Growth

Every single investor has to face a certain level of risk when investing in the capital markets, ranging from bonds and equities to derivatives. Diversification can be effective in optimizing the risk-return payoff through well-structured asset allocation. Simply speaking, investing in asset classes with alike market performance could lead to huge reward, or huge loss as well. Comparatively, the exposure to diverse assets with different or even opposite performance is therefore a great hedging strategy, leading to stable investment return in the mid- to long-run.

Customization for the Best Allocation

After knowing the importance of diversification, we still have to face a quantitative issue of “what is the percentage of each asset class in a diversified portfolio?”, which has to do with customization.

As said in the book “A Random Walk Down Wall Street”, the risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income. Your earning ability outside your investments, and thus your capacity for risk, is usually related to your age.

Therefore, there is not a “best” portfolio for everyone. A responsible asset manager has to develop the investment decision for a particular client based on the well-rounded mastery of his/her financial situation and beyond.

Personally, I interned at AIA Hong Kong office as a financial planner last summer. One of the tasks I accomplished was “financial health check interview”. The goal of the interview was to understand the financial status of clients and ensure their benefits from total protection. In the fact-finding stage of the interview, I collected financial facts, including income level, family expenses, aggregate debt, and investment style, as well as non-financial facts, including age, family status, diagnosed illnesses, smoking & drinking habits. The integration of all these facts would offer a strong fundamental for the execution of a tailor-made financial solution spanning insurance, savings, and investment.

In conclusion, a truly diversified portfolio is not the result of a random selection from various asset classes in the market. Instead, it is derived from in-depth analysis of their features and correlations, as well as the client’s earning power and risk appetite.

Part II: Challenges in China’s Ongoing Financial Reform

In my previous post, I introduced two of the four main challenges facing China as the country is set to optimize its financial system. In this post, I will discuss the rest two—the inflationary pressure and the effective use of private capital.

Apparently, inflation should not be an issue for the country, given the fact that its economy is slowing down, and the Federal Reserve had started to scale back the massive bond purchase program, leading to significant capital outflows from emerging markets. However, there is not a definite link between inflation and money supply. Instead, inflation has a lot more to do with the level of economic activities. In spite of a slowdown in terms of growth rate, China’s economy is still growing rapidly at around 7.5% with increasing number of the middle class, pushing up inflationary pressure naturally. The concern was somewhat eased as China’s Consumer Price Index rose 2.5% in January from a year earlier mainly due to muted food prices. According to estimates by J.P. Morgan, the index might pick up later this year, averaging 3% in 2014. The expected level is still below the government’s stated tolerance of 3.5% but implies another worry for growth, which is weaker domestic consumption. So the government has to face a continuous trade-off between inflation and domestic consumption for sustainable development.

Regarding the incorporation of private capital, it is a welcome trend that would inject vigor to the lumbering, state-dominated banking sector, but a stronger framework of regulations has to be developed to ensure fair play in the capital markets. For instance, Alibaba, China’s Internet giant, recently broke into asset management business by launching a money-market fund called Yu’e Bao. The fund initially offered super appealing returns of around 6.8%, which was much higher than those of traditional bank deposits, but then slid to around 5.5% in anticipation of declining interest rates. In addition, there are concerns that a significant portion of the fund flows into untested and unregulated investments eventually, threatening the stability of the overall financial system. People’s Bank of China Governor Zhou Xiaochuan said recently that while the central bank wouldn’t crack down on the products, it would improve regulations. But how to regulate those private players while offering ordinary Chinese people as many money-making channels as possible remains unclear.

In conclusion, I am bullish about the country’s financial reform as long as the four challenges above could be managed effectively. In particular, the leadership has to deal with existing interest groups wisely to reduce resistance and share growth dividends nationwide.

Part I: Challenges in China’s Ongoing Financial Reform

China, the world’s second largest economy, is undergoing a significant transition from being overly dependent on exports and investments to relying more on domestic consumption for sustainable growth. The leadership pledged to allow the market force to play a fundamental role in the overall economy and open closed fields to the private sector and foreign competition. In order to accomplish the structure upgrade, financial reform is indispensable, including liberalization of the interest rate, internationalization of the Chinese yuan, and incorporation of private capital, etc.

In my observation, the country has to deal with four main challenges to realize its ambitious goals mentioned above.

First, the stability of the Chinese yuan has to be improved. The yuan had been on a steady appreciation path until late February, and then the Chinese central bank started to engineer a decline in the yuan by instructing state-owned banks to buy dollars and allowing the yuan to move as much as 2% on either side of the parity rate on a daily basis, leading to a sharp depreciation of 3% against the U.S. dollar. The reason behind was to drive out international speculators who had been pouring tremendous capital (“hot potatoes”) into China in anticipation of the endless appreciation of the yuan. The influx of speculative capital made the Chinese government harder to manage its economy, triggering potential housing bubble and inflationary pressure. From the long-run perspective, the central bank is trying to introduce greater two-way volatility of the yuan before allowing the market force to play a more critical role so as to ensure its stable movement and promote its international use as an important global currency.

However, this move triggered criticism from Washington as the U.S. Treasury Department said that the yuan’s depreciation would “raise serious concerns” if Beijing is moving away from the plan to make the yuan’s exchange rate market-based, especially if Chinese officials are at the same time citing greater flexibility in the currency’s value.

My prediction is the yuan will resume its appreciation path in the near term because of the Chinese government’s stimulus package. Meanwhile, the People’s Bank of China has to intervene in the yuan in a way both effective and also globally acceptable in the future.

Second, credit quality deterioration is emerging. The non-performing ratio of Chinese banks rose to 1% at the end of the fourth quarter from 0.97% at the end of the third quarter last year, which is the highest since the end of 2011. Many loans were made on the expectation of higher growth rate and the slowdown could lead to serious default issues. To make matter worse, the credit concern spread to Hong Kong since the city posted 30% surge in lending to China on tight credit in the mainland and lower interest rates in Hong Kong.

The Impact of China’s Slowdown on Hong Kong

China’s economy is slowing down, as its GDP grew at 7.4% in the first quarter this year, a level below the 7.7% growth last year and the double-digit growth many years ago.

Relatively, many people are concerned about the prosperity of Hong Kong, whose economy is heavily tied to China through trade, tourism, foreign direct investment, and financial channels. In my observation, there are two main risks for Hong Kong—export growth and credit quality.

China’s growth momentum has long been exports and government-led investment projects. Meanwhile, the country as the world’s second largest economy is also a significant importer due to its huge domestic market of 1.35 billion people. Therefore, many Asian economies, including Singapore, Taiwan, South Korea, and Vietnam, have heavy export exposure to China. In particular, Hong Kong appears to among the most exposed with almost 30% of its exports to China. Since domestic consumption is weakening on the overall economic slowdown and potential risk of a housing bubble, Hong Kong’s exports are highly likely to slide, dragging down the special region’s GDP growth.

Besides, surging loans to Chinese borrowers by banks in Hong Kong triggered concerns on the city’s financial stability. It is due to tight credit in China and lower interest rates in Hong Kong that lending to mainland businesses by all authorized institutions has increased from about 5% of total banking sector assets in 2007 to nearly 20% today, according to the Hong Kong Monetary Authority. As a result, total mainland-related exposure amounts to 165% of Hong Kong GDP, despite that 43% of the outstanding loans come from foreign banks operating in Hong Kong, rendering a comparison to the city’s GDP less relevant.

The worry is that the booming lending might increase uncertainties in Hong Kong’s banking sector and result in overwhelming integration with the Chinese economy. There are signals of credit quality deterioration in China, as the non-performing ratio of Chinese banks rose to 1% at the end of the fourth quarter from 0.97% at the end of the third quarter last year, which is the highest since the end of 2011. Many loans were made on the expectation of higher growth rate and the slowdown could lead to serious default issues.

In response to the higher risk of cross-border leverage, the HKMA decided to regularly conduct on-site examinations of banks’ credit-underwriting processes, as well as regular stress tests to assess banks’ resilience to credit shocks. Specifically, it said it has written to banks that have posted higher-than-average increases in total lending and asked them to make sure they have enough “stable” funds.

The Inception of Cross-Market Stock Investment in China and Hong Kong

The new-established administration in China is ambitious to progress structure reform for sustainable growth. With the claim that the market force will be allowed to play a fundamental role in the overall economy, a key task on the to-do list is the opening-up of its strictly controlled capital markets.

Recently, the country made a big move by initiating the so-called Shanghai-Hong Kong Stock Connect, a pilot program of cross-market stock investment. It allows mainland investors to trade shares of select companies listed in Hong Kong, while permitting Hong Kong investors to trade designated stocks trading in Shanghai. More specifically, investors in Hong Kong can plow up to 13 billion yuan ($2.1 billion) a day into mainland shares, with a maximum of 300 billion yuan. Mainland investors can send up to 10.5 billion yuan a day to Hong Kong, capped at 250 billion yuan. Purchases will be limited to dual-listed stocks and designated blue-chips, and mainland participants will initially have to be either institutional investors or retail investors with 500,000 yuan ($80,650) in securities and cash.

The inception of the program significantly boosted the two markets, with the Shanghai Composite Index ending the day up 1.4%, the biggest gain in the region, and Hang Sang Index (Hong Kong) climbing 1.5% to its highest close since Jan. 2. Both markets are rebounding after sharp falls in the first quarter on concerns of China’s economic slowdown.

Definitely, the cross-border integration will be a mutually beneficial cooperation for both China and Hong Kong.

On the side of China, the Shanghai market has been long-depressed shown by the negative year-to-date performance of the Shanghai Composite. The program will inject vigor into the bear market by introducing foreign capital. In particular, since shares of companies dual-listed in Shanghai and Hong Kong are usually cheaper in Shanghai, mainland investment will be appealing to global investors who can easily trade those dual listed companies in Hong Kong.

On the side of Hong Kong, Hong Kong Exchanges and Clearing Ltd (HKEx) has been struggling to lift trading volume and further capitalize on China’s growing opportunities, despite that the market has comparative advantage of mature accounting practices and transparent regulations. As mainland investors are set to invest in iconic Chinese companies listed in Hong Kong such as Lenovo and Tencent, Hong Kong’s role as the primary gateway to China will be strengthened along with increasing market confidence.

In the long run, the move is expected to push forward the internationalization of the Chinese yuan and bolster Hong Kong’s position as an offshore yuan center by integrating capital domestically and internationally.

Auto Sales in China: Multiple Players, Multiple Strategies

China, the most populous country in the world, is always a critical market for auto makers. In spite of the fact that its economy is slowing down, many people are still bullish about the potential of auto sales in the country because of the increase of middle class, as well as the government’s goal of boosting domestic consumption for economic growth.

Both domestic and foreign auto makers displayed their latest (probably coolest as well) cars along with gorgeous models to attract potential buyers’ attention at this week’s Beijing auto show, and many of them are really ambitious about their China business. For instance, Toyota Motor Corp., the world’s largest auto maker by sales, aims to take the third spot in the country in terms of market share by bringing 15 new car models to Chinese consumers by 2017 and doubling its sales to two million cars over the long run. Similarly, Volvo Car Corp. said it expects China to overtake the U.S. and become its biggest market this year based on a statement issued Sunday, in which the Swedish company said it sees sales of at least 80,000 in China, up from 61,146 in 2013.

So what kind of strategies are auto makers adopting for sales growth? In my observation, the top three concepts are branding, patriotism, and youth-targeted design.

First, branding is essential for every single auto maker. Most buyers in China are not industry experts and cannot tell the difference between two similar-level cars based on technical factors. Therefore, what really helps a particular auto maker stands out is branding. Simply speaking, manufacturers have to think how to make their cars look both reliable and fancy to consumers, instead of being overwhelmingly focused on technical excellence.

Second, patriotism can be an effective selling point of domestic brands. Makers like Geely Motor Corp. and Great Wall Motor Corp. are trying to persuade buyers, especially those elders, to remain loyalty to Chinese brands. However, I think those domestic manufacturers have to increase quality and enhance industry structure to stimulate sales radically.

Third, youth-targeted design is emerging to be a dominant theme. Unlike many Americans under 30 who are burdened with college debts or wrestling with a sluggish job market, China’s young consumers have “incredible resources”, which is derived from the one-child policy in the country. As a result, many top auto makers like Mercedes-Benz showcased what they described as sport-utility vehicle coupes — SUVs with fast-looking roof lines that look to be borrowed from a sports car to attract young buyers.

In conclusion, I think there is not a best strategy for all auto makers, and they have to target the right buyers based on their unique selling points such as design, price, momentum, etc.

Weibo’s IPO Debut: Celebration of China’s Most Influential Social Network

Shares of Weibo jumped 19% in its trading debut at Nasdaq this Thursday. The company ended the first day at $20.24, a significant rehearsal of the lackluster initial pricing of $17, which was at the bottom line of the projected range of $17 to $19.

So what exactly is Weibo? It is an affiliate of the Internet giant Sina Corp. and one of the most popular social-media sites in China. People can publish posts, comment on others’, and discuss over hot topics on its platform. Considering the fact that a great many celebrities are active users of Weibo and have thousands of millions followers, it is widely acknowledged as the Chinese version of Twitter.

Some facts

China has the largest number of internet users of around 570 million (42% of the entire population) in the world, and Weibo said that it had grown to 144 million of monthly active user as of March. The company reported a net profit of $3.38 last year with sales of $188 million, against $38 million in losses. In addition, its revenue in the first-quarter this year grew 161% from a year earlier, reaching $67.5 million.

Ongoing challenges

In spite of the brilliant achievement, I think the company still has to face three main challenges for sustainable growth.

First, the model of profitability is yet to stabilize. Like other major social-media sites, Weibo has obtained a broad user base but is still struggling to be profitable. An interesting fact is that many small and medium businesses have been taking advantage of the platform for effective advertising and revenue growth, but the platform itself is cautious when rolling out advertisements on concern that users will be annoyed and abandon its services.

Second, the level of user activity is yet to stimulate. The number of 144 million active users is a little bit inflated because the measure includes everyone who has “logged in and accessed Weibo” during a given month. According to a research at the University of Hong Kong, only 40% of those “active” users actually publish posts and 5% of them—roughly 10 million users—contribute to 95% of the posts on the platform.

Third, it also has to deal with political pressure from government regulation. The censorship somewhat refrains the level of discussions on the platform and even poses potential shutdown risk. So a smart balance between dynamic posts and government commands is certainly a continuous task on the senior management’s top list.

In conclusion, I am bullish about Weibo’s future because of its increasing influence on ordinary Chinese people’s lives, as well as the emerging collaboration with Alibaba, through which Alibaba merchants will be allowed to advertise to Weibo users.

The Challenges of Alibaba’s Yu’e Bao

In my previous post, I discussed the development of Yu’e Bao, a money market fund controlled by Alibaba. With the company’s leading position in e-commerce and the strong client base, the fund tripled in size during the first quarter with a total of 541.28 billion yuan under management in comparison with 185.34 billion yuan at the end of last year, making it the fourth largest in the world in terms of asset value.

Nevertheless, I think there are three main challenges behind the gorgeous achievement.

First, the yield is decreasing. Since the Chinese central bank has been engineering a decline in the Chinese yuan by purchasing the US dollar and increasing the daily trading band of the yuan, interest rates are expected to decrease in the near future. Although Alibaba is able to negotiate higher returns on deposits than what ordinary savors are obliged to accept, the declining interest rates would pose potential risk to the money-market fund. A signal is that the rate fell to around 5.5% now from its peak of 6.8%. Considering the fact that more than 90% of the fund is invested into bank deposits, further slides on return might be inevitable.

Second, traditional banks are fighting back with diversified wealth management products. Those state-owned banks fell behind Yu’e Bao in the competition for liquidity because the rate of a one-year deposit is capped at 3.3%. Nevertheless, they are bypassing the deposit requirement by offering the so-called “wealth management products”, which is just another channel of financing. Basically, they offer higher-than-deposit rates on financial products sold to the general public and then charge even higher rates on lending to government-led investment projects. The return in this scenario tends to be 5%, a level similar to Yu’e Bao’s.

Third, Yu’e Bao will have to face stricter regulation. There have been concerns that a significant portion of the fund flows into untested and unregulated investments eventually, threatening the stability of the overall financial system. People’s Bank of China Governor Zhou Xiaochuan said recently that while the central bank wouldn’t “crack down” on the products, it would improve regulations. Furthermore, since state-owned banks have dominated the nation’s financial sector for years with profoundly political influence, the regulatory authorities might be forced to curb any emerging power just like Yu’e Bao for protection of traditional banks’ profitability.

In terms of Yu’e Bao’s future, I believe there will still be great opportunities down the road because of its private capital nature and the ongoing financial reform in the country. Ordinary Chinese people have limited investment channels, so the promising Yu’e Bao could be a favorable complement to bank deposits and therefore increase their wealth level, an accomplishment in line with the government’s goal of boosting domestic consumption for economic growth.

The Development of Alibaba’s Yu’e Bao

Alibaba Group Holding Ltd., China’s Internet giant, has been diversifying its business exposure from a pure e-commerce provider. The company broke into the financial sector years ago by creating an affiliate called Small and Micro Lending Group, which offers loans mainly to China’s small and medium enterprises. Another attention-grabbing initiative was the inception of Yu’e Bao, which means “leftover treasure” in Chinese.

So what exactly is Yu’e Bao? It is a money-market fund originated from Alipay, Alibaba’s electronic payment system. With Alibaba’s leading position in e-commerce and the strong client base, the fund tripled in size during the first quarter with a total of 541.28 billion yuan under management in comparison with 185.34 billion yuan at the end of last year, making it the fourth largest in the world in terms of asset value. More surprisingly, the surge was done in just eight months.

Yu’e Bao was launched in June last year when China’s banking system was in the midst of a so-called “cash crunch”—state-owned banks were offering higher returns to attract funds and increase reserves after a surge of risky and untested credit growth. However, since the interest rate of a one-year fixed deposit was capped at 3.3% by China’s central bank and the Alibaba-backed fund initially offered around 6%, traditional bank deposits fell short of Yu’e Bao in the competition of liquidity.

Regarding the reason why it could offer higher yields than traditional deposits, it is attributed to Alibaba’s bargaining power with banks. According to the report of Tianhong, the third-party asset management firm in charge of the fund, more than 92% of the fund is invested into bank deposits because of its nature as a money-market fund. Since Alibaba is able to negotiate higher returns on deposits than what ordinary savors are obliged to accept, the yields for the fund’s investors are relatively higher.

Extensively speaking, Yu’e Bao’s popularity was derived from Alibaba’s credibility as a strong and trusted e-commerce provider. On the side of savors, the higher yielding fund offered better-than-deposit returns and convenience as well—savors can withdraw their funds whenever they like. On the side of Alibaba, the development of the fund would attract funds from online shoppers and ordinary savors, making it an extra money-making channel and a potential stimulus for consumption on the company’s online shopping sites, Tmall and Taobao.

In terms of the nation’s entire financial system, the fund has become an emerging power that is challenging those lumbering state-owned banks by pushing them to develop stronger risk management, diversify products offerings, and offer higher yields to savors in the process of interest rate liberalization.