Strategy Note /
China

China: What happened to Hu?

  • A seemingly unceremonious and forced exit from the stage for former leader Hu Jintao

  • It is hard to analyse because we know so little of what happened behind the scenes at the Communist Party Congress

  • The lack of visibility is nothing new in China but such an apparently unscripted public incident is

China: What happened to Hu?
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

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Tellimer Research
25 October 2022
Published byTellimer Research

Almost all of the China Communist Party Congress went according to expectations. But five minutes during the closing ceremony on 22 October that seemingly did not and that segment provides the abiding memory of the two-week event.

Former President Hu Jintao's Exit

Everyone expected President Xi Jinping to secure a third term at the helm of the Communist Party at its Congress over the last two weeks.

Everyone expected a reiteration of existing policies – zero-Covid, dual circulation, common prosperity (and ambitions) – Taiwan reunification, Tech leadership.

Everyone expected his top team to be staffed with loyalists.

Everyone expected a well-choreographed display of unity.

There was more emphasis on security, homegrown Tech innovation and Taiwan, compared with economic reform and global integration. But this was not tantamount to a pivot in policies.

However, no one expected the apparently chaotic scene of Xi’s predecessor, Hu Jintao, being escorted off stage.

No one, frankly, has a clue what to make of it:

  • A show of strength as a graphic lesson to any potential dissenters? 

  • Or, an almost 80-year-old gentleman struggling with a health issue?

And, when no one knows the truth, the result is sometimes to interpret in a way that reinforces existing views.

Open to interpretation

For China sceptics, this was evidence of rumblings over any or all of the following: 

  • Slowing growth (confirmed by the delayed Q3 22 GDP growth data showing merely 3.9% yoy);

  • Trauma of zero-Covid;

  • Quagmire of distressed property;

  • Regulatory crackdown on private sector Tech;

  • Concentration of political power within the party;

  • Inability to de-escalate tensions with the US, which is impacting access to advanced Tech;

  • Ineffectiveness over combatting US military superiority around Taiwan; and

  • Stuttering progress and uncertain returns on China’s international investments, including Belt and Road.

Whereas for China bulls, this incident was a trivial moment of drama amid a Congress where all matters of substance proceeded as expected.

And, even if this was the result of a high-profile public protest, it does not alter the direction of policy under President Xi and his new top team of loyalists.

Indeed, if this was a demonstration of the concentration of power in Xi and his loyalists, it may mean that policy can be executed quickly or, in the event that it is the wrong policy, it can be rectified quickly.

For China neutrals, this incident will reinforce the sense that all important discussions and decisions take place behind closed doors. There is no visibility on the process, only observable outcomes. And those outcomes may trend positively or negatively. Assessments of China, for this group, are made by looking at the rear-view mirror.

For ESG and ethics fundamentalists, this incident is another reminder of an autocratic regime where the concentration of political and economic power overwhelms all investment considerations.

Our view: A cheap underperformer

There is no visibility on debate leading up to policy formulation but there is clarity on the outcome: Xi, his loyalists and the party are the first priority, social stability and national security second, growth and financial independence third, and foreign relations and foreign capital to the degree it supports the preceding three priorities.

This hierarchy is not that different from countries, both in developed and emerging, which are both more democratic and offer more visibility on decision-making.

China has long since fallen out of favour of the consensus of emerging market investors and this is reflected in its deep discounts to its historical average valuation.

China-HK equities among the worst performers in large EM

China-HK equities among cheapest vs history in large EM

The HSI in Hong Kong and the Shanghai Composite in mainland China are on c50% and 25% discounts to their respective five-year medians on trailing price/book.

That discount is now large enough to prompt a revisit of the enduring strengths of the investment case – China’s scale in global manufacturing is irreplaceable, exports continue to grow despite ongoing US tariffs, China's representation in global equity indices remains far lower than its share of global market capitalisation or GDP – and the things that might go well – zero-Covid policy should ultimately relent, and a zero real interest rate implies capacity for policy stimulus.

That discount is also large enough to consider what might go wrong in those alternative large emerging markets that have outperformed China, are valued nearer or at a premium to their historical average valuation, eg India or Saudi Arabia, less so Brazil, where there are risks but valuation remains cheap even after this year’s outperformance.

From an investment perspective, we take China as it is, rather than as we or others might wish it to be. The ethical qualms of investing in an openly autocratic political system are genuine, of course, but they also exist in countries where democracy is insufficiently competitive and merely a veneer for dominant vested interests. And there are plenty of examples of those in both developed and emerging markets.