In 1997, Wired magazine published an article entitled “The Great Firewall of China” which was one of the first Western media sources to detail the Chinese government’s attempt to build a virtual moat around the country’s computer networks. The consensus opinion of America’s top pundits and politicians at the time was that the Chinese Communist Party’s (CCP) efforts to control internet access would be fruitless, like “trying to nail jello to the wall.” Almost 25 years later, China has developed a mature cyberspace ecosystem segregated from the U.S. and the broader Western world. While Facebook, Google, and Amazon are ubiquitous here; China has WeChat, Baidu, and Alibaba. Thus, some of the world’s largest companies were created through a decades-long government strategy that baffled even the most astute analysts.
It is with this history in mind that we contemplate the puzzling and tumultuous activity in the Chinese economy during 2021. The CCP has cracked down on some of its biggest tech companies like Alibaba and Tencent, the world’s largest video game company, by way of a slew of new regulations that seem to severely impede corporate profitability. It also disrupted the initial public offering of stock of Didi, the Chinese equivalent to Uber, on the New York Stock Exchange this June, exasperating international investors. Adding to this turmoil is the recent news that the Evergrande Real Estate Group, one of the largest property developers in China and a Fortune Global 500 company, is unable to make all of its debt payments. Because the real estate market is so vital to China’s financial system and Evergrande had so many transactions with such a wide variety of domestic and international counterparties, there are concerns about how the CCP will handle such a delicate and difficult default risk.
These jarring episodes and the uncertainty about the CCP’s ultimate intentions have caused Chinese equity indexes to plummet this year, all while the S&P 500 has flirted with a 20% yearly return (see the chart directly below).
The biggest concern for the average retail investor may be the effect all of the Chinese economic agitation has had on the broader emerging market equities sector – one of the fundamental asset classes used in creating a well-balanced portfolio. Despite its enormous size and technological capabilities, China is classified as an emerging market, in large part due to concerns about the type of governmental interference in the financial markets that have come to fruition in 2021. Even with the down year, Chinese companies make up almost one-third of emerging market indexes, as shown in the chart below which breaks down the holdings of iShares Emerging Markets ETF (Ticker: EEM) by country. Thus, China has been able to almost single-handedly drag emerging market funds down into negative territory in 2021 despite positive years from most of the world’s stock markets – for example, Taiwan, the second-largest country in the emerging markets sector, has seen 20% gains this year.
But what is actually going on in China? Well, the 20th Party Congress of the CCP will be held next year where current President Xi Jinping will more than likely be elected to his third term. Some observers of the region have postulated that the government is trying to rein in companies that it believes contribute to greater societal inequality or encourage frivolous activity in preparation of this big event. This means the CCP has punished some of the same consumer tech companies that it had previously spent so many years nurturing. However, as the first paragraph of this article demonstrated, trying to predict the intentions or outcomes of the Chinese Communist Party’s actions can make fools of even the best prognosticators.
Model Update
On Wednesday, September 22nd, the Fortunatus Emerging Growth Companies equity model made a slight reduction in its allocation to the health care sector. There were no trades in the remaining Fortunatus models during the week ending on September 25th, 2021. The major equity market sectors remain in a long-term favorable trend, and the Fortunatus Asset Allocation models are near their maximum allowable equity exposure with domestic stocks favored over international shares.
Past performance is no guarantee of future results. Trend signals are proprietary research of Fortunatus Investments, LLC, a Registered Investment Advisor with the Securities and Exchange Commission (SEC). Reference to registration does not imply any particular level of qualification or skill. Prior to June 2014, Fortunatus Investments was a wholly owned subsidiary of Executive Wealth Management, LLC and they continue to share common ownership and control. Data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation. One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.
Quote of the Week
To teach children about the banking system, a U.S. primary school walked its students to a local bank where each opened a savings account into which each deposited $5. Implicit in this activity is the message that the bank is trustworthy. Another bank then acquired that bank and charged all low-balance accountholders a monthly maintenance fee that wiped out the children’s savings. The children may have learned a more important lesson about the financial sector than the school intended.
A lesson from the financial school of hard knocks from a recent research paper from Loyola Law School professor Lauren Willis entitled “Alternatives to Financial Education”. The professor’s thesis is that one-on-one financial counseling, of adults already participating in the financial world, can be effective in improving personal welfare; however, attempts to impart the importance of financial topics to children have not had a measurable effect on outcomes.
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Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold.
1 Week = closing price on September 17, 2021 to closing price on September 24, 2021
1 Month = closing price on August 24, 2021 to closing price on September 24, 2021
3 Month = closing price on June 24, 2021 to closing price on September 24, 2021
YTD = closing price on December 31, 2020 to closing price on September 24, 2021
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