China: The non-profit tantrum

July 28, 2021

Ken Peng

Head of Asia Investment Strategy

SUMMARY

China’s State Council guidelines to turn the after school tutoring business into non-profits triggered a selloff in Chinese equities. But despite regulatory risks, we do not see a full scale abandoning of capitalism.

During the precipitous selloff, investors looked for who’s next and worried whether China may be taking a left turn too big to own.

We believe that regulatory risks remain, such as for property and healthcare, but are likely much less severe than for education. These are much bigger parts of China’s economy, and are too expensive for the government to foot the bill.

There is also evidence that China plans to continue to push forward market oriented development, as Premier Li Keqiang and Vice Premier Liu He both highlighted in recent days. Abandoning capitalism is also inconsistent with stability at this point.

Ultimately, the purpose of all the regulations is sustainability. The measures are likely to support longer term development of consumer and middle class growth by curbing the cost of basic life needs. It would also solidify control of the central leadership.

There are historical parallels. During the 13th Five Year Plan (2015-19), a lot of steel capacity was destroyed in very blunt ways, causing business owners substantial losses. But profitability followed. There were also retail price reform, manufacturing privatization, local government funding for infrastructure, housing privatization, etc. These were cases of major policy changes that created booms and regulation brought busts, followed by more sustainable development.

The initial selloff is fueled by margin deleveraging and fund redemptions, which is likely to be short lived. Between now and sustained recovery, however, there is likely to be a period of volatility, as investors assess impact on earnings. But looking one year out and beyond, we remain convinced that China’s consumption and technological development would still offer attractive returns.