Would you eat at a restaurant where the chef doesn’t eat his own cooking? Or invest in the shares of a company where the CEO doesn’t buy the stock himself?
Maybe… but you’d hesitate. Does the chef know something that his patrons don’t? And similarly, no one knows the company better than the CEO – so if he doesn’t buy shares in the company he runs, wouldn’t you wonder why?
Those are the sorts of questions that investors should be asking themselves when they look at China. Because right now, Chinese companies are investing lots of money – outside of China.
According to the Financial Times, US$101 billion in global mergers and acquisitions (when companies buy other companies) involved Chinese companies during the first three months of 2016. That’s a huge jump – it’s nearly as much money as Chinese companies spent buying companies outside of China during all of 2015.
The biggest deal was the takeover of Swiss agribusiness company Syngenta by Chinese chemicals group ChemChina. (A Chinese insurance company last week lost out in a bidding war for Starwood Hotels, a deal that would have been the largest takeover of a U.S. company by a Chinese buyer).
Chinese companies have lots of good reasons to invest abroad. They might want to expand to new markets, and spread out where their revenue comes from. Others might want to get the valuable intellectual property that comes with buying certain companies (this can be controversial).
Some companies might want the prestige of owning prized foreign assets. Politically connected enterprises might have geopolitical objectives where profit doesn’t matter. And low interest rates make it easier to finance purchases.
But the bottom line is this: Chinese companies are investing record sums outside of China because they think they see an opportunity to make more money outside of China than inside. No one knows the real state of China’s economy better than the companies operating there.
By voting with their feet, China’s companies are suggesting that they think China’s prospects don’t look good – or at least, not as good as the prospects of elsewhere in the world.
Buying foreign assets is also a way to get cash out of China. “Advisers and analysts have attributed part of the boom to broader concerns over the stability of the renminbi, and suggested that the rapid pick-up in deals in some ways resembles capital flight,” the Financial Times explained.
That’s another way of saying that some Chinese companies think that the renminbi is going to fall in value (which we’ve written about before). Chinese companies are protecting themselves from this by buying foreign assets (which aren’t denominated in renminbi).
The fact that Chinese companies are investing more outside of China doesn’t necessarily mean that you should avoid Chinese shares. The stock market might go up anyway, as we recently explained.
But when investors are leaving their own stock market to invest abroad, foreign portfolio investors (that is, those who buy and sell shares) should be very wary.
For example, back in 1998, foreign portfolio investors couldn’t get enough of Russian stocks. A lot of investors in the west were just discovering the country’s stock market, and shares were cheap. In 1996, the country’s stock market index was up 142 percent, and it rose 98 percent in 1997.
But meanwhile, local investors were selling. Big Russian stakeholders of a lot of Russian companies happily sold their shares to (over)eager foreigners.
And their timing was right… the country’s stock market fell more than 90 percent within months in 1998, as the price of oil (which is very important to Russia’s economy) declined, the government defaulted on the domestic debt market, and the currency collapsed.
Russian investors didn’t have access to any specific information that wasn’t available to foreigners. But they did have a much better sense of what was happening in the market, and where the economy was going. So they were happy to sell to the foreigners (and, very often, buy back those same assets at a small fraction of the cost, months later).
So when Chinese companies don’t invest in China, pay attention… but if Chinese investors stop investing in Chinese stocks, get out – quickly.