Let me preface thee remarks by stating the fact that my wife is Chinese. I have many Chinese friends and family. Nothing I say is intended to reflect negatively upon the Chinese. And while this board is apolitical, I will just assert without elaboration that I also have no animosity towards the Chinese government. Probably most of what you think you know about the Chinese government is wrong, or maybe only half right.
Following are my personal thoughts and observations. I don’t have any empirical evidence, no survey data, etc. So, feel free to completely ignore this commentary. On the other hand, you might find it somewhat interesting or even useful. I won’t know, much less care if you chose to read or exit.
I first travelled to China in 2007. I’ve studied Chinese history and culture. I’m also a pretty good observer of contemporary life in China. Since 2011 I spend about 3 months of the year in China. My wife and I have a modern condo in Guilin, a scenic city in Southeastern China roughly 300 miles northwest of Hong Kong.
In many ways, the Chinese do not seem so very different than the average American. They dress pretty much like most westerners. They own a lot of the same stuff: a smartphone, a flat-screen TV, a refrigerator, a washer/dryer, a car. No, not every Chinese person owns these things. On average more Americans own this stuff than Chinese, but you would probably be surprised to see how modern and “western” China tends to be. McDonald’s, Pizza Hut, Starbucks, KFC and others are everywhere (much to the detriment of the youth. The kids have become noticeably more fleshy than when I first visited). Starbucks is a “hip” place to hang-out.
Of the 1.4 billion Chinese, about 300 million are now considered “middle class” or above. I’m not sure how you define “middle class” but let’s call it people with disposable income to spend on stuff, the ability to satisfy some wants as opposed to just barely meeting needs. And it’s worth noting that while the middle class has been shrinking in the US, it has been growing rapidly in China. Many of the young Chinese are very optimistic about life in China.
While there are many similarities between Americans and Chinese, there are also some big differences. Big, and subtle at the same time. The differences don’t jump out at you immediately. But they are very significant. I think it is important to know and understand some of these differences when it comes to understanding the investing behavior of the Chinese. And even more important if you are thinking of investing in Chinese companies.
My wife and I don’t actually own our condo, though my wife took out a mortgage loan to buy it (before we were married). In fact, it is my understanding that nobody owns their home in China. They lease the land, the government still owns all the land. I believe the lease is 70 years. I’m not sure what happens when it expires, More importantly, my wife doesn’t know either. I think it is intentionally left vague. Single family homes in a city are rare in China. Some of them exist because they were there prior to the revolution. In some areas, developers have created new American style suburban sub-divisions with single family homes. The more affluent Chinese live in these neighborhoods.
But if you pay attention, you can observe some of the important things that makes China very different from America. As I mentioned, we don’t really own our home. No deed, no title insurance, to the best of my knowledge (admittedly, very limited here), nobody has a deed. Real estate transactions routinely close without title insurance. Up until recently, there really was no such thing as a real estate transaction at all. Virtually every home was some form of government housing. The concept of “home ownership” is very new in China. Many of the old ways of thinking prevail. If the home you live in doesn’t belong to you, but rather it belongs to the government would you ever put a new coat of paint on it? Why spend your money to paint a place that’s not yours irrespective of how badly it needs it? I think Home Depot opened a few stores in China. They were a dismal failure. First, the Chinese are rather reluctant to perform home improvement projects. Second, there is no DIY culture in China. If you can afford to buy a home, it is beneath your dignity to perform this kind of work. And even if you wanted to DIY, there’s no place to store tools and materials. And labor is still relatively cheap in China.
The condo we have in China is in a development which is still being developed. There’s a strong, reliable homeowner’s association that faithfully performs routine maintenance and provides services like security, trash removal, etc. In that the developer is still building and selling new units, he is motivated to keep the place looking clean, new and desirable. I am apprehensive of what will happen when he completes the development. I am concerned that the majority of “homeowners” will decide that the homeowner’s association is a needless expense. There is a contractual obligation for the homeowners to pay the association fees as long as they own one or more units (more on the notion of owning multiple units later). But the practical matter of fact is that the obligation is meaningless.
There is virtually no enforcement of civil law in China, for that matter, legal infrastructure is pretty much absent altogether. As I said earlier, as profound as some of the differences between China and America are, they are simultaneously not obvious. I spent a lot of time in China before I realized that I had not seen so much as a single court house. People don’t have to overtly fire the HOA, they simply stop paying the monthly fee. The HOA will curtail services, I imagine most people will continue to demand and pay for garbage removal (even this will not be viewed as indispensable by some). But burned out walkway lighting will not get replaced. Landscaping may be allowed to go wild, etc. How do I know? I’ve already seen this to be the case at more than one completed development. The developer where we live delivered some units late. The owners took him to court. They wanted compensation for living expenses they had to pay while their units were still under construction. The homeowners won, the developer was found guilty and a judgment was found against him. He was obligated to pay monetary damages. He didn’t pay. Nothing happened.
I’ve discussed this situation with my wife. I’ve suggested that if things start to deteriorate, we should sell the home. She’s not very receptive to the idea of selling. So I don’t belabor the subject, I’ll wait and see if it becomes an issue.
But this is where things get interesting with respect to an investment discussion. My wife has often said that our home is now worth significantly more than what she paid for it in 2010 (I think, maybe 2009). She arrives at the appreciated figure based on the current selling price of similar condos in the same development. Earlier, I mentioned that some people own multiple units. The primary motivation for owning multiple units is an investment vehicle. The savings rate in China (among those who have disposable income) is reportedly north of 30%. Those who are able save in China do so primarily to pay for medical services as they age. After the revolution, numerous services were provided by the government, medical services were among them. But one of the economic “reforms” ushered in under Deng XiaoPing was the removal of numerous government provided services. Medical services was one of them. In keeping with the apolitical nature of this board, I’ll refrain from expressing my opinion on this. Most of what has been referred to as the economic “miracle” of modern China can be traced back to the reforms under Deng XiaoPing. I’ll just say nobody bats 1,000 and leave it at that.
But let’s say you are one of the growing number of Chinese able to set some aside for old age. You’ve got a problem, where do you put the money so that it’s value is not destroyed by inflation. Measuring inflation is tricky business, but the official number is around 5% - 6% annually since the mid 1980s. There are not many investment vehicles in China. Up until very recently real estate was the only game.
When you buy a new home in China, you get an empty cement box. Basic plumbing is roughed in, and wired services (electrical, cable, phone) are brought to your box, but that’s it. The breakers, outlets, switches, fixtures, etc are not installed. Same for the plumbing. All this stuff is provided and paid for separately by the new owner post closing of the real estate transaction. Generally, one hires an interior decorating firm that works with the owner to decide on water heating, heat and AC, fixtures, appliances, furnishings and so forth. The service then acts as a general contractor who hires electricians, plumbers, carpenters, etc. to turn the box into a living space. In case it’s not clear, electricians and plumbers cut pathways in the cement box in order to install all the physical wires and pipes. If you’re living in a building that still undergoing “decoration” let me assure you, this is a noisy proposition.
But let’s get back to the investment discussion. First, aside from the fact that there are limited options for investment in China, real estate satisfies some of the very basic investment objectives of the Chinese. Chief among them is the fact that it is tangible. In general, it is my observation that the Chinese greatly prefer tangible investment vehicles to something like a certificate of deposit. When you own a cement box, you own something you can touch. When you own a CD you have a promise from and institution. Another one of my observations is that the Chinese greatly prefer new things as opposed to previously owned things. I’ve seen several auto dealerships in China, but I don’t know what happens to used cars. Maybe they get taken in on trade and then resold somehow, or shipped out of the country or I don’t know what, but I’ve not seen a single used car dealer. There is nothing like Goodwill or Value Village or whatever in China - at least I’ve not seen such a place. When my mother-in-law died all her clothes were burned, nothing was donated, there was no place to make a donation of previously owned clothing. This leads me to believe that there is not much of a market for used anything. It likewise brings into question the value of our home. One might think that having the plumbing, electrical, finished walls, doors, kitchen counters and cupboards, etc. all in place would add to the value. All a new owner need do is bring their furniture. But I’m not so sure. I think the interior decorating cost was about $50k (USD). It may actually reduce the value of the home because it’s not new. At the least, I’m sure it reduces liquidity. There’s a lot of competition with new homes.
Let’s say you own a few cement boxes. For the most part, there are no real estate taxes in China (I think Shanghai is one of the few cities that has implemented some form of real estate tax, primarily to impede real estate speculators). Most folks in China do not buy homeowner’s insurance of any sort. The boxes are not rental units, it costs too much to make them homes, and it possibly reduces value, liquidity or both. So, once you pay for the box, you don’t have any additional cash outlays, except HOA fees. As you might imagine, investors are torn. They loathe paying the fees, but they also want to preserve the value of their property.
I’m not exactly sure when it once again became legal for Chinese citizens to buy gold, but it has been relatively recent, maybe around 2000. Gold also satisfies the basic criteria of being tangible, and it’s portable and generally liquid. Indeed, China represents the largest gold buyer on the planet (or maybe 2nd largest after the US). Prior to the revolution, the Chinese banking system ran on silver. Somewhat less portable than gold, but apparently there are very few gold deposits in China, so there was only a very limited internal source. Silver ore is more plentiful. In any case, gold is still in demand. But, from what I’ve read, gold has lost some of its luster in China. Demand for the yellow metal is tapering off. So where is the money going? My guess is the new game in China is the stock market.
Although there was a stock market in China as early is the mid 1800s, the modern market didn’t really get underway until about 1990. So there’s about 25 years of “experience” with stocks and bonds in China. But, realistically, stocks were not favored by investors for most of the markets 25 year history. Stock holdings are not tangible. The average Chinese person new to the middle class and disposable income is not inclined to invest in this vehicle.
To understand stock market activity in China, one needs to understand another aspect of Chinese culture. The Chinese are very superstitious and they have a penchant for gambling. Macau, the former Portuguese colony in China is the only legal casino location in the country. Macau is tiny. The permanent Chinese residents of Macau are under a million. Nevertheless, the Macau casinos churn money at over 6 times the rate of Las Vegas. Steve Wynn and Sheldon Adelson are the primary American beneficiaries of this activity, and they both swear that their operations are squeaky clean and scrupulously adhere to both Chinese and American law. And just to prove it, they both attack journalists who even begin to suggest that they may be running afoul of the Foreign Corrupt Practices Act with enormous defamation lawsuits. Enough so that no publisher is willing to go to court over it. It’s intimidation and it works. A recent documentary film made for Frontline was just killed by PBS.
I asked a Chinese acquaintance of mine for an opinion as to whether the Chinese made investment decisions about stocks or if it were something more akin to gambling. The first response was telling, “I don’t understand the question.” I explained that investing was based on a study of the company, their products and an evaluation of the future prospects of the company, gambling was like playing poker or betting on a horse at a race track. There is still some skill and knowledge involved, but chance was the largest factor and the outcome was expected in the very short term. After considering this explanation my Chinese friend replied that some Chinese may invest, but the overwhelming majority viewed the stock market as a gamble.
Admittedly, this is an opinion of one individual. But I accepted it as confirmation of my suspicions. I was not surprised to see the recent turmoil in the Chinese market. In fact, given the temperament of what I consider to be typical of the Chinese “investor”, I think it was totally predictable. The market went up rapidly, as far as momentum would carry it. Once it peaked, it fell off a cliff as “investors” bailed as quickly as they could in order to not give up whatever profits they had garnered. I’m sure the late comers lost some money. But I don’t believe many people were “wiped out.” I doubt that many folks had their entire savings in the stock market. Of those that did, I suspect the majority were young and still hold jobs. The older Chinese tend to be very conservative. I think it extremely unlikely that many who were both old and held savings had them in the stock market. Like my wife, their money is mostly in the bank, or maybe cash in a jar at home.
Before you invest in a Chinese company I encourage you to consider the company you are keeping. If the average Chinese investor considers investing a gamble on quick profits, what do you suppose might be the prevailing attitude of management towards the investor community? IMHO, if you conclude that there are mutual feelings of disrespect you are not far off the mark. I believe TMF has made recommendations for Baidu, Tencent, Ali Baba and maybe some other Chinese companies. And some of these have performed very well. My personal feelings are that there are a lot of good non-Chinese investment opportunities. Why gamble on the management of a Chinese company to look after ones interest?