OUTLOOK FOR INTERNATIONAL BOURSES
China and Hong Kong
1996 was the year of the Rat in China. But to the people who move
the world's money around the globe, the single most significant accomplishment
this year in China was the continuing lowering of inflation. The leadership
of China has shown astuteness in managing an economy that is both growing
incredibly fast and undergoing a transition from a planned state-owned economy
to something altogether new: A planned market economy.
The best news of 1996 was caused by China's leaders' flexibility
and pragmatism in managing their economy. The worst of China's failures
during the year stemmed from the same leaders' unwillingness to compromise
in other areas - showed most clearly in domestic social issues. A lengthy
prison sentence for a prominent dissident, the firing of the popular editor
of the Beijing Youth Daily Newspaper, and negative comments made by the
Foreign Minister regarding the future of Hong Kong's press are all examples
of events that led to international criticism and made Hong Kong considerations
more difficult.
Beijing's tendency to take the hard line was also reflected in
certain economic arenas, such as WTO negotiations, which remain stalled,
and in the regulation of China's fledgling equity market, which resulted
in an end-of-year crash. In both cases, when pragmatic, market-driven decision
making lost out to more dogmatic, hard-line communist policy, China's people
came out the real losers.
All in all, though, it was a positive year. These successes of
the past year give the world confidence in the future of Hong Kong. For
that confidence to ultimately be justified, however, the pragmatic - and
conciliatory - approach towards Hong Kong must win out over the dogmatic
and confrontational approach.
Another piece of red ....
This is the year Britain relinquishes control of Hong Kong to the
Chinese. Too bad for the citizens of Hong Kong. The freedoms they once enjoyed
are eroding quickly, as the Hong Kong elite quietly prepare for communist
rule.
The intelligentsia, which was first to be wiped out in China when
Mao took over, doesn't want to meet the fate of its predecessors.
Since 1984, more than 500,000 Hong Kong Chinese have packed their
bags, closed their bank accounts, and left the colony. Because they don't
want to be there when China takes back the city on July 1, 1997.
Britain alone has authorized 50,000 passports to civil servants
who no longer want to stay in Hong Kong.
In Vancouver, Canada, the huge Hong Kong exodus has turned into
a Canadian talent search. Anyone who arrives from China with US$1 million
to put in a bank account or a business with 50 employees ... gets instant
Canadian citizenship as soon as he steps off the plane.
These people are getting out because they realize what a lot of
"gaga" Wall Street investors do not - China isn't looking for
a free economy. They're after power. And control. It's simply too risky
for the Party bosses to let 2 billion isolated people get in touch with
the outside world.
China has been a winner in many of the difficult negotiations with
Britain. China has solved infrastructure problems, has arranged to control
Hong Kong's treasury, and (much to the consternation of British officials),
China has also replaced Hong Kong's current government with a new government,
which was chosen by a 400-member, Beijing-appointed, Selection Committee.
The biggest difficulty in the transition of Hong Kong will be in
Beijing's handling of Hong Kong's free press. Qian Qichen, China's Foreign
Minister, stirred controversy late last year when he said that Hong Kong's
press would not be allowed to criticize China's policies or government.
When the head of Hong Kong Affairs tried to clear up the confusion caused
by Qian's statements he said that the freedom of the press would be maintained
and that, of course, no criticism of China would be allowed.
To Westerners this is an apparent contradiction; to the Chinese
it is as it should be. The political leadership of China considers freedom
of the press to mean that the press is free to report the good news of China's
leadership and growth. There will be no true freedom of the press in Hong
Kong, and everyone already knows it.
Newspaper editors are already censoring themselves ... not to offend
the coming Red Chinese mandarins. Television programs - anticipated to be
viewed as subversive by Chinese authorities - have been pulled. Even benign
entertainment like crossword puzzles have been sanitized - omitting anything
that could be construed the wrong way.
The British, on the other hand, are trying to leave democratic
roots in their wake. (They didn't exactly rush the job in the first 90 years
of their rule, so results will almost certainly be skin-deep at best.) The
Hong Kong Parliament has passed a law which gives a strict definition of
subversion. In essence, the law defines subversion as the use of force.
Anything else is legal protest.
The purpose of the law is obvious. The British don't want the Chinese
to crack down on Hong Kong the way they took care of the Tienanmen uprising
back in 1989. But there is no doubt in our minds that the Chinese will most
definitely overturn this law once they take control.
Many political activists in Hong Kong aren't going down without
a fight. There have already been democracy marches in the streets of downtown
Hong Kong. When China takes control and sends military units to the city,
these marches could turn into a bloodbath.
The future of Hong Kong is vital to the future of China. There
may be some rough spots during the next year, as there would be with any
changing of the guard, but expect the markets and the world to react extremely
positively to the absence of catastrophe. One indicator of the prevailing
positive attitude is Hong Kong's real estate prices, which have sky-rocketed
this fall, rising around 40 percent on average.
Any widespread civil unrest following the handover would likely
be stirred by Hong Kong's Democratic Party, which has boycotted the new
provisional government. If there is an especially harsh crackdown on personal
freedoms, or if Democratic party members are forced out of decision-making
roles, there will be problems. For now though, this seems unlikely.
The WTO
Another item on China's agenda for 1997 is the continuing pursuit
of membership in the World Trade Organization (WTO).
WTO membership would greatly enhance China's international reputation
as a trading partner - marred in 1996 by unscrupulous traders, widespread
infringement of intellectual property rights, and capricious tariffs.
WTO membership would also open China's markets to more foreign
investment, something many sectors sorely need. Regardless of the clear
advantages to membership, China will most likely fail in their WTO bid this
year (to begin formally in February) because the country's leaders refuse
to commit to a "road map" of tariff reductions.
Instead, the Chinese are demanding admission as a "developing
nation," a status that would allow the county to keep a longer timetable
over which to reduce tariffs and open up more of its industries to foreign
competition.
The United States says it will never allow this because of its
growing trade imbalance with China. (In 1997, China will surpass Japan as
the nation with the largest bilateral surplus with the United States.)
China's WTO status and their U.S. trade surplus will come into
the international spotlight in the middle of next year when a summit between
Bill Clinton and Jiang Zemin takes place. China will find it more and more
costly to their economy to remain outside the WTO and will come under increasing
pressure to give in to at least some U.S. demands and join with a hybrid
developing/developed nation status. The power industry's need of foreign
investment, the banking and financial sector's need of more expertise, and
China's own growing manufacturing surpluses will be the leading pressures.
The economy
Great strides were made this year in inflation reduction and next
year should see near double-digit real growth rates. The stage for this
year's growth has been set by the last three years of high interest rates
and an austere budget policy, measures that ended late last year.
Even with last year's lowering of interest rates, inflation continued
to fall, from 9 percent in January to 6.1 percent in December. China has
gotten a handle on growth and for the moment has achieved a difficult soft
landing, due mostly to shrewd management by China's Finance Minister Zhu
Rhonji.
Next year China will have to tackle failing state-owned enterprises
(SOEs) and their mountain of bad debt, private industry's general overproduction,
and an energy shortage caused by years of industrial expansion. WTO membership
would help greatly to solve the two latter problems, but it is the former,
the SOEs, that will prove the most problematic.
There is no clear solution as to how to dismantle the thousands
of failing SOEs. They are not competitive; they produce below-market quality
goods; they must carry the burden of cradle-to-grave care of their employees;
and they have been spoiled by easy credit, which they now cannot repay.
China will attempt to merge as many SOEs as possible with listed companies.
It is hoped that this marriage will compel the SOEs to streamline
their operations to make them profitable. The human cost in unemployment
will be significant, as will the financial costs due to the amount of bad
debt that will have to be written off.
In order to minimize civil unrest, it is likely that the government
will have to increase social spending as new armies of unemployed are created.
It is hoped that over time continued high real economic growth will help
the economy absorb these workers as parts of productive companies, fully
subject to competitive pressures.
The markets
China has two separate equity markets: the A-shares and the B-shares.
A-shares are for domestic investors and B-shares are ostensibly only for
foreign investors, though local investment in B-shares through off-shore
accounts is frequent.
The wide discrepancy in valuations between the two types of shares
offered by the same companies provides the incentive to break the rules.
The average A-share P/E ratio is 55, while the average B-share P/E ratio
is only 19.
Demand for B-shares and interest caused by the coming handover,
helped China's markets to have an incredible year, especially in the month
of November when the B-shares nearly doubled.
The past year has been filled with speculation regarding the government's
position on the equities markets, because for some periods the government
would seem to allow domestic investment in B-shares, then suddenly crack-down
on local B-share trading. Apparently, it is the government's desire to regulate
the markets to slow, steady growth.
By manipulating the rules surrounding B-share investment they control
demand, and thus equity prices. Any wild surges or stunning declines bring
the wrath of the regulators and a crackdown in domestic buying of B-shares.
During the year, when the markets would be stalled in long downturns,
rumors would be floated that local investors would soon be allowed to invest
in the B-share markets. The markets would shoot up wildly, then sink when
the government would belie the rumors by cracking down on local investors
again. Changing regulations and uncertainty generally kept foreign investors
on the sidelines.
It remains unclear if China is serious yet about developing a steady
market policy that would allow fluctuations in the market's value according
to free market principles.
For now, investment in China's markets is extremely risky. Another
way to invest in China is to buy Chinese companies whose shares trade in
Hong Kong (known as H-shares). These Chinese companies meet Hong Kong's
more stringent accounting standards and have been chosen by the Chinese
government to list on Hong Kong's stock exchange rather than Shenzhen's
or Shanghai's. When investing directly in China, realize that there are
significant political risks that exceed those found in most emerging markets.
Taipan's 1997 Forecast (Market Ratings):
Hong Kong: Bullish, Medium Risk Shanghai: Bullish, High Risk Shenzhen: Bullish, High Risk
But
there are other implications for investing in China. The most important:
We think high-tech and communications companies won't thrive in China.
Why, for instance, would a Chinese peasant without a phone need
a modem? And where would a Chinese family put a computer (assuming they
could afford to part with the three years of income it would cost them)
when they're still sleeping six to a room? And why would they risk it, knowing
that possession of a computer or an Internet address could be the only evidence
needed to put them in prison for life?
This is the real glimpse of China today. And we predict that the
kinds of wealth explosion everyone else is promising now will have to take
place on the other side of a crisis - something that will dislodge the current
power structure.
Don't lose face
By all accounts, the Chinese government does not want a disruption
in the Hong Kong economy, or more specifically, the stock market.
Given the capitalist frenzy among the comrades in Beijing, major
economic changes appear unlikely. After all, most foreign investments enter
China through Hong Kong.
There's an interesting contrast between the Hong Kong stock market
and the United States stock market. Currently, even after the mini-correction
this past December, the U.S. stock market is still over-valued. Stocks are
trading at 20 times earnings.
By historical standards, this is extremely high and dangerous.
A correction of 25-30 percent can occur, similar to the 1987 crash.
The Hong Kong stock market is trading at 13 times earnings. But
the difference is that Hong Kong is trying to manipulate the market to go
even higher. They would love to see the market trading at 20 times earnings.
But the Chinese don't see this as a major problem. In ancient Asian
culture, there's the concept of face, which is respect in the eyes of your
peers. Face is still a powerful motive today.
The Chinese will do anything to keep the stock market rising. But
in terms of value, the Hong Kong stock market has a while to go before it
hits the U.S. value.
Still a good bargain
Regardless of the politics of Hong Kong, you still want money in
the market, because it is cheaper, and the growth rate much higher.
Plus, Hong Kong gives investors ample opportunities to buy at market
bottoms. Since 1987, the Hong Kong stock market has undergone 4 corrections
- 1987, 1989, 1991, and 1994-1995. In each correction, the market was bailed
out by the high growth rate, which allowed investors to make fortunes.
As far as the stock market for 1997 is concerned, the odds on at
least a 30% drop in share prices are growing steadily. The main reason is
the heavy-handed trampling on Hong Kong sensibilities by the Chinese.
That said, long-term investors should be prepared to take major
positions in Hong Kong stocks in the event of a major decline. Look for
bargains. You can still find stocks that have a 25-30 percent growth rate
and P/Es in the mid-teens.
Taipan likes a broad exposure in the market, especially in blue
chips. Companies Taipan will watch in the coming year will be China Light
and Power (CHLWY: OTC) and Hong Kong Electric (HKSE), as well as the other
companies that have traditionally made up our Dragon Portfolio: HSBC Holdings,
Sun Hung Kai Properties, Hutchison Whampoa, CITIC Pacific, and New World
Development.
If you don't want to track each individual security individually,
we recommend you buy shares in the no-load Guinnes Flight China & Hong
Kong Fund. It closely mirrors our Dragon Portfolio picks. For more information,
contact Guinness Flight Global Asset Management Limited, P.O. Box 9070,
Boston, MA 02205-8993, tel. (800)915-6565 for fund information.
Our favorite individual China play is much closer to the true motor
of Chinese economic growth. Listed in Hong Kong, CP Pokphand (CPP) is part
of the Charoen Pokphand Feedmill group, Thailand's largest agri-business
and a leading supplier of feed and poultry in Thailand, Indonesia, and Turkey.
Chicken in every wok
CPP's main business is China, and it's in two industries: chickens
and motorcycles. It is the leading supplier of poultry. And as millions
of Chinese move up into the middle class, their diets will contain less
cereal and more meat - especially chicken.
CPP also has a 70% stake in Shanghai-based Ek Chor Motorcycle,
which already owns 17% of the rapidly expanding Chinese motorcycle market.
In addition to its Hong Kong listing, CPP trades over-the-counter
in North America in ADR form (CPPKY-OTC).
For more information, contact CP Pokphand, 22/F Far East Finance
Centre, 16 Harcourt Road, Hong Kong; tel. (85-2)2520-1601; fax (85-2)2861-2514.
We will keep you updated on Hong Kong throughout the year. As it
turns out, James Passin will be in Hong Kong the day the Chinese take over
and bring you the hottest Chinese profit opportunity as it emerges from
history in the making.
Philippines: Seeing is believing
If you haven't been to the Philippines lately, then you are missing
out on an emerging market with real value. The only problem: Nobody believes
it.
The Philippines have been the garbage can of the Pacific for so
long that nobody - especially the Filipinos - believes that conditions can
get better. And who can blame them?
The Marcos government was a crony capitalist regime - where only
the rich and well-connected were offered monopolies and tax breaks. The
poor were left out to fend for themselves.
Aquino - although a benevolent leader to her supporters - was a
completely ineffective president.
If you visited the Philippines during the Marcos-Aquino years,
then you know those were the days when power went off every day at half-past
noon, because there wasn't enough electricity to power the country.
Conditions were terrible. A tropical climate without the relief
of air conditioning or even an ice maker. An old saying about the Philippines
- when arriving by boat - was "you'll smell it before you see it."
Capitalism has returned
But now the Ramos government is in place. The days of crony-capitalism
are over.
Ramos is the first really effective leader in the Philippines since,
maybe, MacArthur. He has sold off state-owned assets ... opened up the economy
to foreign investors by actively seeking foreign capital ... and reinvested
in infrastructure. Moreover, he is treating foreign investors and companies
with respect, something his predecessors were unable to accomplish.
Under Ramos, the economy is growing between 5 and 8 percent annually.
Unemployment is shrinking and wages are increasing. This hasn't happened
in generations, which is why it is such a shock to the natives.
The government even temporarily thought about seizing the fortunes
of all capitalists who made their millions during the corrupt Marcos years.
Lucio Tan, the Philippines' tobacco and beer tycoon, was first on the list,
when he pulled a quick move to save his assets - he took over the ailing
Philippine Airlines.
The country's airline was scheduled for break-up, which would've
put 14,000 employees out of work. Tan's takeover saved those jobs and has
had positive psychological effects on the economy.
Executive term limits
But there is a serious political problem. After the devastating
Marcos years, the Philippine people decided to do what the Republicans did
after the Roosevelt years, ratify a constitutional amendment limiting the
president's terms.
So the question that everybody is asking: What happens when Ramos
goes? Currently, Vice President Estrada is the next likely candidate.
Estrada is very popular with the people. He was a former action
movie star. But his leadership is suspect. However, if Ramos can lay a strong
foundation for a stable government, then the next leader should have a less
difficult time continuing the progress.
Invest in the Philippines
Third World telephone companies have been en vogue of late, especially
in emerging markets. Philippine Long Distance (PHI-A: NYSE) is one of them.
At current levels of US$55, Philippine Long Distance is pricey. Wait for
it to fall below US$50 before buying. The company fundamentals are sound
and show excellent growth over the next year. But don't get caught in a
trend which isn't supported by value.
Taipan's Forecast for 1997: mildly bullish, medium risk
Thailand: A royal mess
The Thai stock market is in terrible shape. Recent changes in government
have created a chaotic situation which nobody can fix. King Bhumibol Adulyadej
issued a royal proclamation in September dissolving the parliament and called
for new elections.
This surprise move came just one week after Prime Minister Banharn
Silpa-archa, under pressure from allies in his six-party coalition government,
promised to resign.
During parliamentary debate on a no-confidence vote, the coalition
partners convinced Banharn to agree to step down in exchange for support
of Defense Minister Chavlit Yongchaiydh, leader of the New Aspiration Party
and former army chief of staff, as the next prime minister.
Banharn's coalition government was extremely unpopular during its
14 months in power. Urban middle-class voters in particular found his Chart
Thai Party to be both corrupt and incapable of managing the state.
Major changes in the country's political lineup are likely to result
from the dissolution of the parliament. There have been increasing calls
for an overhaul of the political system - changing the constitution if need
be.
Although the newly formed parliament has the authority to reject
these changes, a constitutional convention including both Thai and foreign
experts has been convened to find ways to address various problems, including
the rampant corruption. This may prove to be a Sisyphean task: as long as
the government has favors to sell, someone will be willing to buy.
Slowing economic growth
At the same time, economic growth in the country is slowing: Although
the Central Bank target for GDP growth for 1996 is 7.8 percent, private
economists tell Taipan that GDP is more like 6.2% for the year, compared
to a growth rate of 8.6% in 1995.
Thailand's deficit is soaring to record highs ... mostly because
they spend a lot of money on foreign products. At first glance this is bad
news. But once you realize what the Thai government is buying, the deficit
isn't that bad. The government has been purchasing capital goods - machinery,
factory supplies, and building supplies.
The
money they spend is actually being reinvested in infrastructure and the
economy.
Stock prices collapsed in Thailand during 1996. However, stocks
are still expensive on a P/E and dividend yield basis, especially in the
construction, communications, and development and building sectors. And
it's just as well that they should be, given the 7 percent per year growth
rate. Still, a couple of bargains stand out.
Taipan's favorite in Thailand is Singer Thailand (SINGER: BSE).
It trades at about US$6.50, has a low P/E of 7, a price to book of about
2, and a huge dividend of nearly 12%. As always in volatile markets, maintain
a rigid stop-loss of about 30%. Opportunity will always return in this region,
so if you can't get in at reasonable prices, don't get in. Wait for the
trend to end before buying.
Taipan's 1997 Forecast: mildly bearish, medium risk
Indonesia: Blood in the streets
The biggest problem for Indonesians is their president-elect for
life, Suharto. He's in his 70s, sick, and his wife recently died. Because
of this, many opposition parties have emerged to run against him in the
elections. But the elections are rigged ... and have been for the past 30
years.
Besides, Suharto is in no mood to have his leadership challenged
while he's in office. He rules the country with an iron fist ... as evidenced
by the bloodbath that occurred over the summer.
The government is intent on pursuing strong action against the
groups that rioted in July over the government's interference in the activities
of the opposition Indonesian Democratic Party, and there is no respite from
the fallout over the violence.
One ominous element of the situation: the military may have taken
it upon itself to organize the government's moves in hopes of ensuring that
a senior military official becomes the next president if Suharto decides
not to run again in 1998.
Suharto himself continues to give mixed signals about another term,
but the events of July and August suggest that he will step down. Military
leaders want him to resign by the middle of 1997 so that one of their supporters
can be appointed to the presidency, virtually guaranteeing a victory in
the 1998 election.
This disorder may also help to initiate a broad-based middle-class
movement insisting on more democratic processes. If so, the military will
play a pivotal role in determining how peacefully the process evolves.
But Taipan believes that the Suharto regime is good for Indonesia.
His crony-capitalism has produced 7-10% growth for the economy in the last
several years.
Indonesia has a vast amount of natural resources, especially oil,
which caused the country much economic trouble in the 1970s and 1980s. But
they diversified their economy, which is why it is growing at a healthy
7+ percentage clip.
But many questions remain unanswered. Even though the military
is positioning itself for future leadership, what will happen when Suharto
dies or steps down? The last time there was a transition of power - in the
early 1960s - more than 250,000 people died in the streets.
Indonesia simply doesn't have a smooth transition-of-power mechanism
like the United States. And Megawati Sukarnoputri - the leader of the Indonesian
Democratic Party and the most popular candidate among the people - is likely
to cause trouble if the military begins rigging the voting process.
Taipan's 1997 Forecast: mildly bullish