The most interesting thing about this trade is that it seems so obvious. The risks in China are likely overblown and if you believe that good businesses will prosper over the long-term, this is a great risk/reward ratio. I see several tailwinds which I’ll explain below.
Firstly, I think most of the Chinese company tax-selling is done. Taking a look at last years chart you see that any investors who took a long position in KWEB over the past year are likely down. Given the strength of the U.S. market, I think it’s very likely they’re using the loss to offset gains in their U.S. portfolio.
The last day to take losses for the 2021 year was on December 29th (T+2 settlement). On December 30th, Chinese stocks such as Ali Baba saw a 5%+ increase in price. While maybe a false positive, I think this was a hint that most of the selling in the last months of the year was due to tax-loss harvesting, I even took a loss in BABA in early December with the hope of coming back in 30 days later.
Given the mounting risks in the U.S. market, money needs to go somewhere and I think China offers a good risk/reward. It’s likely you’ll see more institutions increasing their exposure to Chinese companies. The internet sector is particularly attractive as a growth sector for a lot of institutions. As such, I’m looking for strength this January as those who harvested tax-losses retake their positions.
It’s particularly hard to time the reversal, if there is going to be one, so I’ve started with a small position in Jan 20th ‘23 calls and seeing what happens. The convexity in the options means my delta increases as the price goes higher and decreases as the price drops. This is probably my favorite thing about long options: they have built in risk management.
Depending on what happens in the next couple of weeks I have a couple of choices. If the trade starts to fall I could enter a levered synthetic and get my delta above 1 if I think it’s coming back. If new information comes out or I change my view I can use a short call to enter a bear call spread. That’s my game plan so far. I’ll keep this blog up to date as the trade progresses.
Why I’m not afraid of the CCP or other pressures in China
I am in no way an expert on the Chinese stock market. I’ve come to my conclusions from what I’ve read so I could be entirely wrong. That being said, I’m comfortable with the position and am ready to face the consequences.
The Chinese stock market is much different from the U.S market. Retail investors make up the majority of the Chinese stock market (Source: UBS) and most are short-term focused (Harvard Business Review). That means there is higher volatility but many more chances for long-term “value” investors.
I think the worries about China are overblown but so does everyone else. That is my one hesitation about Chinese investments: they’re obvious.
I follow several Asian fund investors but Li Lu is my go to. I think he has a far greater understanding of the China and U.S. dynamic. While China is gaining power in the global space, the U.S. is still dominant globaly. It’s in China’s best interest to play by U.S. rules. I don’t mean that they aren’t capable, I mean that they can benefit hugely from it.
Charlie Munger is another hero of mine and his sizable stake in Ali Baba through the Daily Journal adds to my confidence. I also understand that he takes a much longer term view. The Daily Journal will likely hold these shares for decades to come.
Munger’s fascination with China makes a lot of sense. As a value investor you have to look where markets are inefficient. China is a great example as the markets are filled with short-term focused retail investors. Institutional money management isn’t mainstream unless you go to Hong Kong. It’s a great market for those willing to look deeper.
Further Reading and Videos
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