Doug Young Positions For 2016: More Pain Ahead For Chinese Markets

by: Doug Young


China's stock markets could remain a very volatile place in the year ahead.

Is a major economic slowdown on the horizon for the world's second-biggest economy?

While Chinese firms have encountered resistance among U.S. investors, could there be some undervalued plays?

China presents opportunities for U.S. firms, but some hurdles remain.

It was a rough New Year start for Chinese stocks. The nation's markets tumbled 7% on the first trading day of the year as investors worried about economic turmoil and a possible new correction. The investor angst surfaced after a tumultuous 2015 - at one point last year the Shanghai stock exchange lost about a third of its value.

Is there more pain ahead for China?

Doug Young has spent nearly a decade covering Chinese companies and the economy. He resides in Shanghai, and delivers commentary and analysis daily via his blog. He spent some time with Editor Michael Hopkins outlining his observations for the year ahead.

Michael Hopkins: One of the big stories for investors in 2015 was the rocky Chinese stock market. Things have started rough for the New Year. Could China's markets present an opportunity - or more trouble - in 2016?

Doug Young: As we saw in the first trading day of the New Year, China's stock markets could still remain a very volatile place in the year ahead. The main indexes are still well above where they were when the original rally (dating back to late 2014) began, meaning there's still plenty of room for correction. Part of the reason for their recent stability has been extraordinary measures the government took during last year's sell-off, including strict limitations on selling by big shareholders. There was also an unreasonable expectation by small retail buyers that the government would come in and rescue them if things got bad again. But with China's economy facing numerous fundamental problems going into the New Year, the government may decide the stock market is a low priority and choose to focus on bigger issues instead. That could translate to a lot more downward pressure for Chinese stocks, though the government is likely to step in again if it feels things are getting out of control.

MH: What should U.S. investors know about the state of the Chinese economy, now and in 2016?

DY: China's economy is currently facing many issues that will be hard to fix and are likely to cause problems in the next few years. Chief among those is a real estate market that's extremely overpriced, with home values in big cities like Shanghai well above those in most western markets even though most Chinese earn a fraction of the money that westerners earn. The other big problem is overcapacity in many other sectors like steel and other raw materials. Most of that is at big state-run companies that have largely refused to act commercially and instead are economic tools of local governments to create jobs and other economic activity. But many of these companies are now stuck with lots of excess capacity and have flooded the market with their products, to the point where they're losing big money. Something has to give, and we can probably expect to see a major economic slowdown as all these issues get sorted out.

MH: Qihoo (NYSE:QIHU) is about to complete its $9 billion privatization deal. Other Chinese companies continue their move from the U.S. back to markets in China. Are we nearing an end of the Wall Street exodus for Chinese firms?

DY: This one is hard to call. I've always believed that big companies like Baidu (NASDAQ:BIDU) and Alibaba (NYSE:BABA) are better served by listing in the U.S. or Hong Kong because such markets are better regulated and therefore the companies are more honest and credible in the eyes of investors. Overseas listings also give these companies access to more mature western financial markets, which are more stable than China's. But many of the smaller companies that are de-listing are probably better served by returning to China, since few US investors are familiar with them and their trading volumes are often very small. As a result, many of these smaller companies probably are undervalued.

MH: U.S. companies made key moves into China - Disney (NYSE:DIS), Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) among them. What are the opportunities for U.S. firms in China in 2016?

DY: Opportunities in China will come in a number of areas that Beijing considers priorities for development. Chief among those are the Internet, which is what we've seen with Amazon and Google. Entertainment is another big area thanks to China's fast-growing middle class that has led to an explosion in online video entertainment and a booming box office. A third area where we could see some strong growth is financial services since China is also rapidly opening up this sector. Visa (NYSE:V), MasterCard (NYSE:MA) and PayPal (NASDAQ:PYPL) are all expected to finally get licenses to operate electronic payment services in China this year, and so is Apple (NASDAQ:AAPL).

MH: What are the challenges for U.S. firms?

DY: The main challenges for U.S. and foreign firms in general is the slowing Chinese economy and also China's inherent favoritism towards domestic companies over foreign ones. As the economy starts to slow, Beijing may become friendlier towards foreign firms as a vehicle to prop up economic growth. But sagging demand due to the economic slowdown will hurt everyone, both Chinese and foreign companies.

MH: Google has made an interesting move, getting back into the Chinese market. But they aren't doing search. Can the company thrive with its apps approach?

DY: Google should be able to do a good business in China with its app store, but the real key will be selling its Nexus smartphones in the market. I suspect Google's moves to open a China app store are part of a two-pronged strategy that will also see the company launch its latest Nexus models in the market at the same time as a Google Play store China launch. Google really needs its own hardware to promote its Google Play store, since most of the Chinese smartphone brands already have their own app stores and are unlikely to promote Google Play, even though they all use Android. Google already has a partnership with Huawei, which is making one of the latest Nexus models. So Huawei would be a natural partner to launch the Nexus brand in China.

MH: And Apple's chances in China in 2016? Can it compete with the likes of Xiaomi, others?

DY: Apple already competes quite effectively in China, and is the nation's top high-end smartphone brand. The company commands the most loyalty among any Chinese smartphone brands, so I don't expect them to face much new competition in the New Year. The one brand that is making some headway in China these days is Huawei, but I expect them to take market share from other Chinese brands like Xiaomi and Lenovo rather than Apple.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.