China, the great 21st century growth story, has shown serious signs of strain this year. Both the Shanghai and Hang Seng indices are in the red in 2013, despite a generally strong equity environment globally. The 3 year chart of the Hang Seng shows that it’s basically in the same spot it was 3 years ago:
Stress has been building in the Chinese financial system for some time (remember the suicides in the credit squeeze of 2011?), but the situation has clearly gotten worse in the past month. FTAlphaville had a thorough rundown yesterday of the implications of the rise in Shibor, the Chinese interbank offered rate. Stimulus or monetary easing are not the easy fixes they once were for China. The new government is finally trying to address the imbalances, but it’s a painful, long road ahead.
Declines in commodity prices, particularly metals, declines in Chinese and other emerging market equities closely tied to the Chinese growth story (like Brazil), and declines in Australian-related assets are all longstanding signs of slowing industrial demand in China. The recent financial stress is just the latest chapter in a story of overcapacity.
But largely unnoticed, there is one sector in China that has side-stepped the broader troubles – Chinese internet stocks. As Alibaba prepares for its massive IPO, other Chinese internet stocks like QIHU, SOHU, and Tencent (700 HK) have had a very strong year:
QIHU 1 year daily:
SOHU 1 year daily:
Tencent (700 HK) 1 year daily:
Even weaker performers like BIDU and SINA have outperformed the Chinese market, and have turned in the last couple months.
The Chinese government is finally serious about shifting the economy more towards consumption and away from fixed investment. From a bird’s-eye view, that’s a painful transition. The large banks, construction companies, industrials, and commodity companies will get hurt. Individual property investors, who own apartments in empty cities, will get hurt. International producers catering to Chinese demand will get hurt.
However, there will be winners as well. The Chinese internet sector will be one of the largest single sources of consumption demand in the world over the next decade. Relative to developed markets, it is still in its infancy. The stocks are signaling that investors are willing to provide the sector with capital, despite China’s systemic troubles.
I expect more weakness in Chinese markets in the months ahead. The imbalances are too large. Don’t throw the baby out with the bath water, though. Chinese internet stocks are the oasis in the desert.