China Trip Report
Comment of the Day

April 21 2015

Commentary by Eoin Treacy

China Trip Report

Eoin Treacy's view

The first time I visited China was in 2005 and I didn’t stop coughing until we got back on the plane to leave. The pollution was such that you couldn’t see more than 100 metres in any direction for the entire time we were there and I didn’t think to wear a face mask. It was November. 

Utilities burn large quantities of coal in North China between October and March for heating which results in heavy smog across a wide swathe of the country. From April the weather heats up so heating demand goes down and the air improves. I’ve been to Beijing in the summer and autumn but this was the first time in the spring and the air was cleaner than I’ve ever seen it before. Visibility was up to about a mile and there was a powdery blue sky overhead. 

Mrs. Treacy has often talked about the dust storms that hit Beijing in the spring as well as the willow catkins that fill the air. We experienced both on this occasion. The catkins in particular looked like snow on the freeway and delighted my daughters. 

In the aftermath of the documentary movie posted by Chai Jing, which was viewed 200 million times before it was taken down, there is heightened awareness of the problems with pollution, be it air quality, integrity of the food chain or ground water. 

As the Chinese economy transitions away from the fixed asset investment model these considerations are affecting how business people approach opportunities. One Beijing property developer I spoke with lamented that the focus of attention has moved to the biotech, social media and retail sectors not least when it was the construction sector that got China to where it is today. His opinion was that the property markets of major Tier 1 cities such as Beijing, Shanghai, Shenzhen, Guangzhou and Chengdu would be relatively insulated in the same way that London,  New York and Sydney have been resilient but that the Tier 2 and 3 cities are at much greater risk of difficulty. 

We also talked about the roll out of property tax which he agreed was a necessary step but faced obvious difficulties since people don’t like paying more tax. He did say it was inevitable and would be implemented, at least to his knowledge, within three years.  The lowering of reserve requirements for the banking sector, which are still the highest in the world, can be seen as a positive development of the stock market. However it is also worth considering the reason for such action. The pace of default in the state owned and private sectors is increasing. With the first default of a state owned company today this is no longer a theoretical situation. We are seeing a major reorganisation of the Chinese economy. This is likely to be painful for the sectors with the greatest oversupply but of benefit to others as liquidity conditions ease.

Nevertheless, the performance of the Shanghai Property Index highlights that there will be some clear winners and losers from this reorientation and that large caps stand to benefit.  
In another conversation with a family that sold their air conditioner factories a year ago I asked how they saw the situation developing. He said that the general practice to date has been for private companies to be absorbed by state-owned companies. Where resistance has been evident, licences have been revoked and the merger takes place anyway.  That family’s newest venture is in cleaning up ground water and recycling water for refineries and they have also bought a business manufacturing LED street light bulbs. This might not be a trend but it certainly helps to highlight that people who have done extremely well from the infrastructure boom are transitioning to sectors more in line with the new focus of the government.   

I recreated the Chinese Water Companies section of my Favourites in the Eoin’s Favourites section of the Chart Library. What’s particularly interesting is that trading has been suspended in a number of names over the last week. This is usually as a result of insider selling or because of merger activity. 

Beijing Enterprises Water is representative of the sector and the wider market. It completed a yearlong range three weeks ago and is susceptible to some consolidation of the gain. However, a sustained move below HK$5.50 would be required to begin to question medium-term upside potential. 

Singapore listed Hyflux has been trending lower for four years but found at least near-term support in the region of 70¢ in December and posted its first higher reaction lows in two years from March. It is now testing the region of the 200-day MA and a sustained move above S$1 would begin to bolster the recovery argument.  

It was also a pleasure to meet Illumina’s Chinese partner who not only sells Illumina’s products in China but is building a factory to manufacture sequencing machines in Hangzhou and also has a 23andMe type genetic testing service. Perhaps the most interesting data point is that to have your genetic sequence decoded in China costs approximately $1500 and takes two weeks. She said they do in one week but take the extra week to check their results before issuing them to the client. Those are impressive figures and help to emphasise that China might still need to import technology but has advantages in other areas that can help improve costs of production in highly technical fields. 

Illumina continues to find support in the region of the 200-day MA following setbacks and a sustained move below $180 would be required to question potential for additional higher to lateral ranging. 

Sequenom is a much smaller competitor but has now broken a more than three-year progression of lower rally highs. 

There has been a great deal of commentary about the encroachment of artificial intelligence in the creative process and the impact this will have on sectors which have previously been unaffected by automation. On this trip to China I was surprised to see how popular Hatsune Miko has become. She is a wholly artificial persona manufactured using a Yamaha Vocaloid machine and whose voice is sampled from that of a voice actor. One might reasonably argue that the Japanese have a penchant for technology that surpasses just about every other culture but it would appear inevitable that other avenues will be found for artificial intelligence in the entertainment industry. 

China’s great firewall is effective at ensuring that Facebook, Twitter, Google and Youtube are unusable. It is possible to skirt it using POP servers but that was beyond the technical knowhow of my seven and nine year olds who felt cut off from their daily intake of YouTube videos. What I found interesting is that LinkedIn does not appear to be sanctioned in any way by the Chinese administration. 

The share rallied three weeks ago from the region of the 200-day MA and a sustained move below $240 would be required to question medium-term scope for additional higher to lateral ranging. 


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