Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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September 18, 2021

Levelling Up China Style

Risking capital when the risk-free rate is negative – The case for Pinduoduo 

You might have thought that the victory of tobacco company Phillip Morris acquiring the billion-pound respiratory disease specialist, Vectura was the most ironic thing to happen in markets this week. Consider also the news that the FCA is to spend £11m on “influencers” as part of their campaign to dissuade retail investors from taking excessive risks with their savings. The irony is that the primary force driving savers to seek higher risk results directly from the actions of the Treasury and Bank of England.

Events like this raise the question of whether governments do more harm than good. Of course, we can debate this subject, whereas most Chinese people cannot. However, the trade-off for them is that while we are frustrated by the ineffectiveness of our politicians, they have a government that gets stuff done. In the words of George Carlin, Xi Jinping is the Joe Pesci of “levelling up” [https://www.youtube.com/watch?v=PlzbFxYy08c&ab_channel=DianaClarion]. By contrast, Boris served the cold dish of revenge on his old friend Michael Gove this week. Tasking him with the hot potato of planning and “levelling up” in the reshuffle reminded me of Flight Lieutenant Perkins from Beyond the Fringe. [ https://www.youtube.com/watch?v=Y5YW4qKOAVM&ab_channel=frogandpeach1]. Gove’s new posting is like being handed the Northern Ireland Office in the 1970s, a futile gesture.

China’s “levelling up” is called “common prosperity”. Along with measures to restrict its people from gambling and playing video games, they are also “nudging” their consumers into buying fewer Louis Vuitton handbags. The crackdown on private education is a tacit acknowledgement that China is dealing with a demographic time bomb. Not for them the option of immigration. They need to boost baby production.

“Dual-circulation” policy demands a sharp rebalancing of resources away from consumer internet applications and towards advanced manufacturing technology. The Chinese young are being redirected from video games into hard science skills unless, of course, you happen to be a Muslim living in Xijiang and haven’t passed GCSE cultural studies.

The rapid deployment of China’s “common prosperity” and “dual-circulation” policies has unsettled financial markets. Media commentary suggests surprise that China is cracking down so hard on its own corporate success stories; how could they commit such acts of self-harm, sound familiar?

George Soros was shocked that Xi doesn’t understand markets when warning us of the follies of trusting the Chinese Communist Party with our capital. George, who knows better than most how governments can distort markets for their benefit, seems not to have learnt from the mistaken belief that allowing China into the WTO would make them more like us. All very reminiscent of the dire warning by Lord Rose of M&S that Brexit might lead to higher wages in the UK, a message heard loud and clear by the voters of Sunderland.

Going against Soros’s well-intentioned advice, I recently bought my first shares in a Chinese company. I own a small position in Pinduoduo (PDD). Well, I think I do. I own a US-listed ADR in PDD shares. I own a financial obligation from a US bank with uncertain ownership over an amazing set of assets in a country with no concept of private property rights.

Why would I do this? The underlying asset happens to be the world’s fastest-growing company. PDD reached a market value of $100bn within five years of inception, thus exceeding the trajectory of any FAANG company. A mobile-only social commerce platform that claims to bring “value and happiness to everyone” reported $3.6 bn revenue from its 850 million users in just the last three months, representing respectively 89% and 30% year on year growth.

Since February this year, the PDD share price declined from $200 to $80 (now $100). If market estimates are to be believed with growth rates effectively halving into 2022, the EV/Rev is about 4x. The actual outcome could be 10x or 2x, but I have assessed these odds as best I can, and for my purposes, they are acceptable.

Despite the best efforts of government policy, with its intended and unintended consequences, human ingenuity has an unrelenting ability to deliver extraordinary outcomes. I believe PDD might be one such opportunity. Both George Soros and the FCA are right, I don’t need to take this risk. But I have chosen to do so because I have assessed that I will make a positive return. I have positioned the risk considering the reality that China is a different country with different standards and objectives than the UK. Position sizing is important, but so too is looking for a supernormal return, particularly when the “normal” return is negative.



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