2019-04-09
Author: Eric (Tianli) Wen, Head of Research
For past Pilgrimage publications, please contact BLRI sales (sales@blue-lotus.cn).
| Stocks mentioned in this email | FHL US, TIGR US, WB US, 700 HK, 3888 HK, JD, PDD, BZUN, WUBA, ZTO, YRD, YY, HUYA, TME, TAL, 1797 HK, 1569 HK, 1317 HK, BIDU, ATHM, BITA, 2858 HK, 6169 HK |
Happy Festival of the Dead!
April 5th is China’s Festival of the Dead (FOD), the tomb-sweeping Festival, or the Qingming Festival, whatever you call it. It is a day to pay respect to one’s ancestors. The origin of the FOD is the Cold Food Festival (CFF). CFF is a day when ancient people extinguish their old fire and start a new fire in their kitchens, during which period their families must prepare enough cold food to eat. Because cold food was easy to carry, people began to set foot for short travels. The most obvious destination is the ancestors’ tombs. So it becomes FOD.
FOD has another significance. In 353 AD’s FOD, or CFF as still called, a group of poets and libertarians gathered in a place called the Orchid Pavilion. What got passed on from that gathering was the absolute No.1 masterpiece of Chinese calligraphy of all time:
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China and US will temporarily wrap up the trade war to prepare for domestic agendas
History is the religion of the Chinese. But it is important to learn from the history of the others, not only the history of oneself. China learned a hard lesson in 1840. The US China relation on the broad terms is on solid foundation and this time it demonstrated again both countries were governed by intelligent, sensible and rational people. The Chinese response to the trade war stems from a nationwide consensus formed through a century of soul searching which led to a unwavering faith to the world’s governing structure. This consensus, in addition to US’s nature as a benevolent power, are ultimately the driving forces behind today’s truce between US and China.
Going forward, both US and China have domestic agendas to attend. For the US, President Trump will set the stage for Election 2020, for which he must demonstrate to the doubtful that he is not a crazy man. He will do that through a trade deal with China.
For China, the long-waited 4th Plenary Session of the 19th Central Committee (十九届四中全会) will take place. It will set the stage for President Xi to consolidate its power.
The Central Committee is the governing body of the Chinese Communist Party (CCP). There are now 203 people on the 19th Central Committee, of which 25 are on the Politburo and of which 7 are in its Standing Committee, including President Xi and Premier Li. The Central Committee is re-elected every five years, which means President Xi (whose party title is General Secretary of the Central Committee) first came to power in the 18th Central Committee in 2012. Normally each Central Committee (now you know it is essentially the shadow cabinet) lasts two terms, which means 10 years. But in the 2nd Plenary Session of the 19th Central Committee in January 2018, General Secretary Xi put forward a motion to modify the Chinese Constitution to remove the term limit of the President. The motion was later confirmed in the National People’s Congress and the National People’s Consultative Conference so it is confirmed by the Party and the Legislature. One of the excuses of the modification, as part of the FUD (Fear, Uncertainty and Doubt) campaign, was that the Party’s Central Committee has a two-term limitation anyway so there is no need to duplicate that in the presidency term. The Party’s two-term limitation, however, is anunwritten rule followed by each government since Deng Xiaoping’s death. We will not know whether
General Secretary Xi plans to follow that rule until 2022 as generally it would be unthinkable that China’s president (the real cabinet) and the CCP General Secretary (the shadow cabinet) will be led by two different person.
But this is not always true. Chairman Mao Tse-tong has never been President of the Country in his whole life even though he has been Chairman, the predecessor of General Secretary of the Party. Deng Xiaoping, on the other hand, has neither been General Secretary of the Party nor President of the Country in his whole life, yet he was in charge of the country for 15 critical years (1982-1997).
Even though history can roll back, but certainly it is not desirable to roll back history. So General Secretary Xi set off a risky course. Following the 3rd Plenary Session of the 19th Central Committee in February and confirmation by the Legislature, the US-China trade war erupted. The 4th Plenary Session never took place.
The flash point of Taiwan is going to burn even brighter
Our interpretation of President Xi’s amendment to the Constitution is less ominous than many think. We believe the motivation is efficiency. Generally speaking, a ten year tenure is not long enough to make the tough changes China must undertake to see through the structural reforms needed. The Jiang-Zhu cabinet (1989-2002) was a cabinet which form the terms for CCP’s power transition. But before Deng Xiaoping’s death in 1997 the Jiang-Zhu cabinet wields little or no absolute power. After Deng’s death, President Jiang Zemin became China’s patriarch but soon he needed to hand over the power to the subsequent Hu-Wen cabinet (2002-2012) which was largely viewed as a bidding-time-treading-water-lame-duck cabinet, applying Band-Aids to structural issues. At the late stage of the Hu-Wen cabinet large scale and rampant government corruption even became the norm.
The Party elders believed this was because none of Jiang, Zhu, Hu and Wen were offspring from the revolutionary family and therefore they didn’t have a stake in the heritage of the People’s Republic. In a contest between Xi Jinping, son of Xi Zhongxun and Bo Xilai, son of Bo Yibo, Xi won, and Bo was sentenced to jail after attempting a military coup. After Xi’s assumption of power, he immediately launched an anti-graft campaign to clean up the image of the CCP. After receiving kudos for what he has done, his next step is to launch Made-In-China 2025.
We believe Xi’s amendment of the Constitution is aimed at completely overhauling China’s reform and national agendas, set the foundation for CCP’s governing of China for decades to come. We have mentioned that China needs to overhaul its tax regime and social security system, steer the country from low end labour-intensive industries to research and innovation and build up the capital market. We have also mentioned CCP intends to unify Taiwan to break the blockade of the First Island Chain (https://en.wikipedia.org/wiki/First_island_chain). These goals are still what the ruling elite of China expects him to do, in our view.
These reform and national agendas set the baseline of President Xi’s presidency and general secretariat. It also sets the agenda for the US policy to contain China. While the ending of the trade war allows President Trump to come home to claim victory, so does it to President Xi. A consolidation of power will take place.
We believe President Xi has NO chance to extend his power beyond 2020 if he cannot make sufficient progress in the above reform and national agendas. This means Taiwan Strait will again become a flash point between China and US. In March 31, two Chinese fighter jets flew over the mid-point of the Taiwan Strait as a response to a possible sale of F-16V fighter jets to Taiwan.
Replay, regroup, recover and return
Following the conclusion of the trade war, each side will replay the scenario, examine the weaknesses and repair the loopholes, recover from the blows, regroup for the future and return to the arena.
This will be especially true for China, in our view. From our observation, China was basically routed at the onset of the trade war. The stock market first caved in. A-share sell side economists and analysts raced to announce defeatism and allegiance to the enemy. Business confidence tanked. Entrepreneurs rushed to emigrate. The upper echelon of China turns out to be the weakest link.
First round of scapegoating has already started. In January 2019 Chairman of China’s Security Regulatory Commission, Liu Shiyu, was removed. Yesterday, famous reform-minded Chairman of China’s Social Security Fund, Lou Jiwei, was removed for his derogatory remarks to South China Morning Post about Made-In-China-2025. We believe there will be more heads to roll.
When the 4th Plenary Session reconvenes, we believe discussions will be held to strengthen the leadership of the Party, which means ideology control will intensify.
Chinese ADR might face another scrutiny in the next 12 months
Chinese ADR has inherent risk and flaws. Technically Chinese government never approved these companies to be listed, neither was their Variable-Interest-Entity (VIE) structure. For the former as long as the securities are not offered to the Chinese there is no victim. For the later, as long as the Chinese entity of the VIE pays taxes, the government should have no grievances.
But the god is in the details. What will be the detail this time?
We don’t know. But one detail might be the two overseas Chinese discount brokers: FHL US and TIGR US. Technically these two companies facilitate Chinese retail investing overseas but in reality most of their clients are share option or RSU holders of the Chinese ADR companies. From our limited understanding there might be two problems: (1) income tax withholding, (2) selling investment advice to Chinese nationals (which requires a license). Of course, another implicit reason is platforms like FHL and TIGR result in outflow of China’s foreign currency reserves, which makes them an eyesore of the Chinese government.
Will Weibo (WB US, HOLD, US$70) face more scrutiny? Absolutely. Just today, WB shut down 50 top dissident accounts, with fans ranging from 7.2mn to 200K, including an innocuous account on Louis Cha’s martial arts novel. The tightening in ideology will soon hit in full force. These measures will increase WB’s content compliance cost.
As Chinese government realizing the importance of a robust capital markets in unite the country and set the agenda of engagement, it will resort measures to build up China’s domestic capital market. There have always been two ways to make that happen, as repeated trial-and-errors in the past have shown: One way is the passive approach: Let the companies decide where to list, but set all kinds of roadblocks to disadvantage the real business on those who list abroad. There are many excuses for the roadblock, national security being the easiest one; Another way is the active approach: Coerce, harass and entice companies to list in domestic exchange.
We certainly prefer the passive approach, but we are afraid that in the next 12 months, we will see more of the active approach. What provides solace is that at least in the short run, ADR listing brings much needed hard currency to China.