Q&A with Michael Fritzell, Editor of Asian Century Stocks

In 2022, (as of January 19, 2023), the S&P Asia Pacific BMI is down 11.45%. Why do you think 2022 was a tough year for folks with exposure to Asia?

The weakness in Asian stocks in 2022 was due to a confluence of factors. One important factor was that the US Dollar strengthened throughout most of 2022. Flows tend to follow performance, and if you measure performance in US Dollars, it increases the hurdle for Asia-focused investors. Outflows out of emerging markets continued, and they remain deeply out of favour.

Another major event was the drop in the share prices of COVID-19 beneficiaries. Consumer electronics companies, rubber glove manufacturers, technology platforms and so on. As most of Asia recovered from the pandemic, their businesses suffered.

Then there was a shift in investor sentiment towards Chinese stocks. Until late 2020, overseas investors were massively bullish on Chinese technology stocks, for example. At that time, they were seen as “compounders” – buy-and-forget stocks that you should be willing to pay up for.

Then, in November 2020, Alibaba’s founder Jack Ma was taken in for questioning. The Chinese government took a tougher approach to deal with what it considered monopolistic behaviour. It all snowballed from there.

Since then, many Chinese tech companies have had to provide so-called “golden shares” to the government. These golden shares have provided the government board representation and – in many cases – actual control of them.

What also happened in late 2020 was a government push for private enterprises to introduce so-called “Communist Party Committees”. In theory, these committees enable the communist party to replace the private sector management teams it doesn’t like.

Since those events, we have seen many tech CEOs resigning, including Zhang Yiming at TikTok’s parent Bytedance, Jack Ma at Alibaba, Richard Liu at JD, and so on.

Tencent and Alibaba’s donations of CNY 50 billion (US$7 billion) each to community projects also raised eyebrows. Some investors viewed these donations as hidden taxes connected to Chairman Xi Jinping’s vision of wealth redistribution in the name of “common prosperity”.

Another issue that caused Chinese shares to fall was the crackdown on private property developers. The government introduced strict leverage requirements on the country’s developers. Anecdotal evidence also suggests that private developers were cut off from bank financing. At the same time, the government made it more difficult for individuals to get mortgages. The result was that many private property developers started a slow descent into bankruptcy. Asian junk bond investors suffered severe losses.

In 2022, the Chinese government doubled down on its policy of trying to completely eradicate COVID-19. But when Omicron started spreading in late 2021, it became increasingly difficult to achieve full eradication. Local governments introduced increasingly heavy-handed tactics to deal with the pandemic, most famously through the 2-month lockdown in Shanghai in April-May last year. By the third quarter of 2022, roughly 250 million people were locked inside their homes.

The final bottom for Asian stocks came with China’s Communist Party Congress in October 2022, when General Secretary Xi Jinping secured a coveted third term. Investors realised that Xi would stay on as a ruler of the country for the foreseeable future. Since he is not a reformer, investors panicked, leading to a final puke in late October 2022.

Conversely. (as of January 19, 2023), Year-to-Date, the S&P Asia Pacific BMI is up 5.29%. Why do you think that is and is this a signal for change in sentiment?

Since Xi secured his third term, the government’s COVID-19 policy has shifted completely. For example, in early November 2022, Chinese state media started downplaying the threat of Omicron, saying that the symptoms were no worse than the flu. On 11 November 2022, the government introduced 20 new COVID-19 policies that, in practice, reduced the risk of strict lockdowns.

A few weeks later, anti-COVID protests emerged nationwide, and state media reported on those protests without much censorship. Whether the protests influenced decision-making or not, COVID-19 restrictions have largely gone away. For example, on 7 December 2022, the government stopped mass testing for COVID-19.

Since then, a significant percentage of China’s population has been infected with COVID-19. Nobody knows the exact numbers, but if I had to guess, the rate of infection probably peaked in early January 2023.

Finally, on 8 January 2023, China’s borders opened up as well. Cross-province travel has now resumed, and we’re also seeing significant overseas travel for the first time since early 2020.

It’s tragic that so many people have died from COVID-19 but at the same time, China’s reopening also provides hope for the future for so many of the country’s businesses, which suffered for so long.

The main beneficiaries of China’s reopening will be consumer- and travel-related companies listed in Hong Kong and mainland China. You can feel the optimism in the air.

How would you say macroeconomic events are affecting institutional perspective towards Asia as a whole? Some folks perceive investing in global equities as a hedge against short term factors, like, if the US goes into a recession – what do you think?

Investing in global equities could well serve as a hedge. In my view, what happened during the pandemic is that the Federal Reserve monetised an unprecedented budget deficit used to fund COVID-19-related cash handouts. Those budget deficits rose 40% in just two years. That should be US Dollar negative, in the long-term. The recent tightening in monetary policy is to deal with this oversupply of dollars floating around.

But we never had such stimulus programs in Asia. There was real suffering in emerging markets during COVID-19. These economies are only now recovering from the pandemic. So fundamentals in terms of economic growth are improving, in my view.

The same is true for China. Monetary policy has been tight since the deleveraging campaign started in 2017. The economic picture was horrendous throughout most of 2022.

So we’re now in an unusual situation where most of the world is tightening its monetary policy while China is in full-on easing mode. While I will agree that Xi is hardly market-friendly, I also cannot deny the fact that fundamentals are improving rapidly in many of the Chinese stocks that I look at.

I think it’s clear that US monetary policy is tight right now, and whether that will tilt the world into a recession is unclear. But I believe that the US inflation rate is coming down rapidly, in which case you’ll want to own long-duration assets such as US Treasuries. At the same time, Asian consumer stocks are cheap and the fundamentals are heading in the right direction. So perhaps global stocks will serve as a hedge, to some extent.

You were recently on the Planet MicroCap Podcast, where you shared that Consumer companies with exposure to China markets may be interesting because of China’s re-opening and loosening of their COVID restrictions. How has that thesis played out so far in 2023, and what other Asian countries should folks look more closely at for 2023 and why?

That thesis continues to play out. Casinos in Macau and Southeast Asia rallied after China’s borders opened in early January. Shares of Hong Kong hotels and retailers continue to rise steadily. Transport stocks such as airports and toll roads are also benefitting. Investors are also starting to become more bullish about oil demand now that Chinese travel is coming back. Fundamentals are clearly heading in the right direction.

The most exciting story in Asia is undoubtedly the reopening of China’s borders and the removal of COVID-19 restrictions. It will benefit not just mainland Chinese companies, but also consumer-related companies in Hong Kong, South Korea, Taiwan, Japan and Southeast Asia. Before COVID-19, mainland Chinese tourists had a massive impact on the economies of Southeast Asia. Those tourists are now coming back.

Another theme I like is the end of the semiconductor chip shortage. The competing demand for chips from consumer electronics is slumping. Auto- and machinery production is now coming back, and many of these companies have record order books. While the demand for autos in the US and Europe might weaken a bit due to the recent rate hikes, I believe that US interest rates will eventually fall towards the end of 2023.

To close us out, if you had to make one prediction regarding Asia for 2023, what would that be?

My single biggest prediction is that optimism will return to Asia – not just among consumers but also investors. The region has been left for dead for so many years. We’ve seen outflows from Japan and Southeast Asia for years. And Chinese stocks became highly unpopular at the bottom last October. With improving fundamentals for many consumer companies across the region, I’d imagine that investors will one day get excited again.

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