The Grass is Greener: Skirting Deflation via Strong Overseas Growth. Again.

There is an 80% chance that the top five performing Chinese Internet and Internet-related companies will be those who manage domestic deflationary pressures via strong overseas performance.

“Fundamental things happen for technical reasons.” Last year punished most Chinese equities with China’s V-shaped COVID recovery empirically lackluster [1]. Beijing has begun to wake up and take preventative measures to forestall normalizing a state of dampened animal spirits. This was evident in the larger-than-expected 0.5% reserve requirement ratio cut on January 24th, which is projected to release 1 trillion RMB into the economy [2].

Chinese Internet companies that navigated last year’s choppy waters were those who played not only in their domestic sandbox. As it were, the key to last year's outstanding price-performance lay in managements’ ability to navigate the domestic markets and grow in global ones. Companies like PDD, VIPSHOP HOLDINGS LTD, JOYY INC, and NETEASE INC emerged as top performers in the KWEB ETF, boasting returns of 79.41%, 30.21%, 25.67%, and 22.79%, respectively. The ETF was down -13.13% during the same period [3].

The aforementioned companies succeeded in taking more share from their domestic competitors as the tastes of a depressed and shell-shocked consumer changed following the abrupt ending of the draconian COVID Zero policy. The phenomenon of “trading down” allowed agile managements to benefit from a more cost-conscious consumer domestically, while internationally, these companies expanded and benefitted from a strong Western consumer [4], thereby mitigating the impact of domestic deflationary pressures.

These deflationary pressures, or “malignant deflation is connected to weak demand that causes a downward spiral in prices. Insufficient demand, coupled with excess capacity, means firms are forced to reduce prices to move their inventories,” [5]. The strategic pivot towards international markets was underscored by the context of China's broader economic narrative. With the economy showing signs of recovery [6] yet grappling with insufficient demand and a cautious consumer base wary of spending amidst knife-falling property prices [7], combating malignant deflation through international success became a linchpin for these companies.

The backdrop of these economic conditions includes a looming window for real fiscal stimulus, particularly around the Two Sessions on March 5, when GDP, budget deficit, and local special bond targets will be announced [8].

I predict the market will likely see this theme play out again this year with potentially different winners, but for the same reasons, as the fundamental landscape has just begun to change.

Sources

1.       Cooban A. Chinese stocks are the big losers of 2023. Oil also had a bad year. CNN. Published December 29, 2023. Accessed January 27, 2023. https://www.cnn.com/2023/12/29/investing/china-oil-miss-market-rally-2023/index.html

2.       State Council of the People's Republic of China. China announces reserve requirement ratio cut. Published July 9, 2021. Accessed January 27, 2023. https://english.www.gov.cn/statecouncil/ministries/202107/09/content_WS60e82fadc6d0df57f98dca96.html

3.       Bloomberg Terminal. Note on TAL Education's 2023 return of 79.15%, highlighting the lack of explicit overseas revenue as a rationale for exclusion from certain analyses. [Accessed January 27, 2023]

4.       Swonk D. Consumers tapped savings to buoy spending. KPMG. January 26, 2024. Accessed Accessed January 27, 2023. https://kpmg.com/us/en/articles/2024/december-2023-pce.html

5.       Crawford PJ, Young T. Inflation to Deflation and Back? Comparing the U.S. to Japan and Germany. Graziadio Business Review. 2003;6(4). Accessed January 27, 2023. https://gbr.pepperdine.edu/2010/08/inflation-to-deflation-and-back/

6.       Yao K, Zhang E. China's 2023 GDP shows patchy economic recovery, raises case for stimulus. Reuters. Published January 17, 2024. Updated 11 days ago. Accessed January 27, 2023. https://www.reuters.com/world/china/chinas-q4-gdp-grows-52-yy-below-market-forecast-2024-01-17/

7.       Gao L, Woo R. China's property market slide worsens despite government support. Reuters. Published January 16, 2024. Updated January 27, 2024. Accessed January 27, 2023. https://www.reuters.com/world/china/chinas-dec-new-home-prices-fall-fastest-pace-since-feb-2015-2024-01-17/

8.       "China's local 'two sessions' convey confidence in 2024 economy." Xinhua. January 28, 2024. Accessed January 28, 2023. https://english.cctv.com/2024/01/28/ARTIdKhpHOjZFuW5ZvyEKMdU240128.shtml