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China’s Hostility To Foreign Business Needs To End
Doing business in China is extremely risky. Things can change, literally, on a whim. President Xi Jinping has to navigate multiple crosscurrents when dealing with foreign business, and underlings have their own political concerns. Investors must be wary of over-investing in a country where their investment could degrade overnight. OSI Group is a regrettable example. Trumped-up charges led to workers held without trial and massive economic damage to the company. Ever since Chinese President Xi Jinping took over, foreign businesses have been rightfully complaining at the hostility Xi has shown them. For much of the past two years, Xi has been pushing his agenda for reform, revitalization, and restructuring. In the process, however, foreign businesses have been subjected to harassment, fines, bureaucracy, and in some cases, outright fabrication of criminal activity. Meanwhile, state-owned enterprises receive government favoritism, and things like intellectual property rights are being dismissed, or adhered to on an ad-hoc basis. The American Chamber of Commerce in China reports that 60% of foreign businesses feel unwelcome, up from 40% last year. The result has been ever-declining foreign investment in China. For example, investment fell 17% in July and 14% in August, year-over-year. Here’s a brief list of some incidents, and then we’ll look at reasons and consequences. Earlier this year, GlaxoSmithKline (NYSE: GSK ) was hit with a $489 million fine for alleged bribery, in a trial held behind closed doors. Earlier this year, Qualcomm (NASDAQ: QCOM ) paid a $975 million fine to settle an allegation that the company had charged “unfair” and “excessively high” royalties for the use of its smartphone technology. Part of the settlement included a reduced royalty calculation that, to one analyst, seemed to be totally arbitrary. Microsoft (NASDAQ: MSFT ) had its China offices raided last year as regulators allege breaches of anti-monopoly laws. Then, without warning, the government banned Microsoft’s Windows 8 operating system from government computers because it was allegedly filled with spyware. The company has been in data privacy dust-ups with China for awhile, but the pettiness and hostility of China towards Microsoft, whose revenue from the country is negligible, illustrates how out of control this issue has become. Yet the most egregious story comes from Illinois-based OSI Group, which should make anyone fume. In July 2014, two employees of the Shanghai government-owned Dragon TV applied for jobs at Husi Foods, the Chinese subsidiary of OSI Group. These “investigative reporters” were hired, but clearly under false pretenses . These reporters strapped on hidden cameras, and one filmed another intentionally dropping meat on the floor. This “shocking evidence” was magically leaked back to Dragon TV, which then aired a trumped-up “exposé”. The fiction grabbed attention of the government, which raided the plant on July 20, 2014, and later arrested six employees of Husi Foods. Subsequently, the Shanghai Food and Drug Administration (SFDA) claimed that Husi sold expired and repackaged meat to its customers. That kind of reputation damage led to lost sales, the loss of KFC (NYSE: YUM ) and McDonald’s (NYSE: MCD ) as clients, and have cost OSI Group hundreds of jobs and hundreds of millions of dollars . Emboldening state-owned media to manufacture evidence serves nobody. According to Professor Joshua Eisenman in testimony before the U.S.-China Economic and Security Review Commission, “In some cases, like that of meat distributor OSI International in Shanghai, entrenched domestic interest and local authorities appear to have made it far more difficult for foreigners to do business in China by clamping down on their operations and employing innovative discriminatory tactics to restrict their ability to conduct business.” No kidding. So what’s going on? Why is China engaging in such antagonism with foreign businesses? One of my sources that does business in China boils things down. Xi has to walk several tightropes. On the one hand, China needs Western intellectual, business, and technological assets to support its own developing tech industry. Paired with this is America’s need to access China’s massive population that has access to the internet – as many as 750 million people. Xi may have been maneuvering for negotiating position. By setting fires that he can also put out, he puts himself in the position of extracting concessions from America, both political and economic – such as killing retaliatory sanctions for its cyber attacks on our federal agencies. Xi also needs to be seen as protectionist, both to the Communist Party and to the general population. China comes first, the West comes second. He must create a delicate balance of carrots and sticks, so that the Chinese reap the benefits of outside investment without sacrificing the competitiveness of Chinese companies. Does this sound like China is focused too much on the macro issues? They are…and they aren’t. According to one source of mine who regularly does business in China, the issues are cultural and political. “The Chinese look at the larger picture, whereas Americans are more discrete in their perspective. Whatever incident occurs, there’s always something behind it that it totally opaque. Sometimes you are being sent a signal. Sometimes you’ve unintentionally offended someone. You cannot pinpoint the specifics of what actually happened. You never know when you are being made an example of, or for what reason, or if you just stepped over some invisible line. It may not even be about you at all, because there are multiple layers and crosscurrents constantly at play.” He provides an example. “Suppose you plan to release a movie in China, and it has a scene where dentists are being made fun of. Six months from now, the International Dentist Conference will be held in Beijing. So the person in charge of policing content pulls out the dentist joke because he doesn’t want to get blamed if the dentist joke offends someone.” Unfortunately, this all comes at the expense of basic human rights. It also comes at the expense of China’s own economic health. Meanwhile, monthly outflows from China have grown from $5 billion to $100 billion, according to the International Business Times . The government has tried to keep the money in-country by monkeying with currency exchanges rules and limits. The AP reports that GDP growth is slowing in the second-largest economy, growing by 6.9% in Q3, the slowest since the financial crisis. Growth in factory output fell to 5.7% in September from 6.1% in August. The government has had to cut interest rates five times. The situation is so bad that it isn’t only foreign investment that’s pulling out. Ever wonder why Chinese firm Dalian Wanda Group purchased the AMC Theatre chain? Or why Shuanghui International spent $7 billion to purchase Smithfield foods? Or any of the other massive deals that have occurred ? Or why, talking about real estate with an agent in Montenegro, so many Chinese are buying land there? So Chinese businessmen can get their money the heck out of China. The future is in China’s own hands, but until it reconciles itself with the fact that the West is going to help it grow, and drops politics from its agenda, it’s going to continue to scare business away. As for investors, I would be extremely cautious about investing in companies that derive significant revenue from China. It’s one thing to understand risks that are quantifiable and invest with an eye towards those risks. With China, however, you may as well invest in a war-torn third-world country where the government might nationalize assets at any time. As my source says, “Your contracts with the government are always at the risk of being broken with two simple words: ‘things changed'” China’s behavior has not only made setbacks to any given company a possibility, but a completely random one. As we’ve already seen, if Xi wakes up one morning and decides to hassle a business whose stock you own, that stock could crater. I would avoid all ETFs that invest heavily in China, ETFs that weight China more than 5% of a portfolio, and any company that derives more than 5% of revenue from China. Yes, that eliminates some big names from your portfolio. However, as a risk-averse, long-term diversified portfolio advocate, why expose to risk you don’t need?
5 ETFs For Loads Of Holiday Shopping Delight
The holiday season saw a gala start on an e-commerce bonanza. Smartphones and special deals on apps took charge of the shopping scene, with brick-and-mortar retail sales clearly losing steam. The Thanksgiving weekend, Black Friday and especially Cyber Monday demonstrate the growing popularity of mobile shopping and changing consumer habits. Further, strengthening of U.S. economic activities and a slew of upbeat economic data, especially on the job, auto and housing fronts, provide strong support to the holiday season, though consumer confidence has been shaky. Recap of Thanksgiving Weekend and Cyber Monday According to RetailNext, brick-and-mortar sales fell 4.7% to $20.4 billion over the four-day Thanksgiving weekend, while it dropped 10.4% year over year, as per ShopperTrak. Meanwhile, online sales grew 25.2% year over year during the weekend, as per IBM, and 25% on Thanksgiving Day and 14% on Black Friday, with combined sales of $4.45 billion, as per Adobe. After a massive surge in online sales on Black Friday, Cyber Monday once again became the heaviest online spending day ever, exceeding over $3 billion in sales for the first time. Online sales jumped 21% from last year and hit $3.12 billion for the first time, as per web analytics firm ComScore . Total online spending climbed 15% to $11 billion from Thanksgiving Day through Cyber Monday (November 26 to 30), according to Adobe. Most of the spending came from mobile devices, suggesting that mobile shopping is on the rise. Sluggish Consumer Sentiment The Consumer Confidence Index measured by the Conference Board – a barometer of the U.S. consumer health – dropped to its lowest level in a year to 90.4 in November from a revised 99.1 in October. On the other hand, the Thomson Reuters/University of Michigan index of consumer sentiment increased to 91.3 for November from 90 in October. The number was well below the Wall Street Journal expectation of 93.0 and preliminary reading of 93.1 recorded in mid-November. This shows that retailers might struggle to win customers this holiday season. U.S. on Track to Modest Growth Amid sluggish consumer confidence, the U.S. economy is showing impressive growth after a lazy summer. Though the manufacturing sector shrank for the first time in three years in November on a weak global economy and a strong dollar, robust automobile sales and construction spending suggest the economy is on a firmer footing. This is especially true as the economy expanded at a solid clip of 2.1% annually in the third quarter, up from the initial estimate of 1.5%, and was followed by 3.9% growth in the second quarter. The solid growth was driven by cheap fuel and greater job security. Hiring came in stronger than expected for November, reflecting back-to-back months of job growth. In particular, the economy added 211,000 jobs in November, much above the market expectation of 200,000, and unemployment remained at a seven-and-half year low of 5%. Further, the pace of hiring in October and September was stronger than previously expected. Average hourly wages rose by four cents last month, following a nine-cent increase in October. Apart from these, a gradual recovery in the housing market as well as stepped-up service activities are propelling the U.S. economy, setting the scene for a decent holiday season. As a result, the National Retail Federation (NRF) expects total holiday sales in November and December (excluding autos, gas and restaurant) to grow at a solid pace of 3.7%. Though this marks a deceleration from last year’s growth rate of 4.1%, it is well above the 10-year average of 2.5%. Online sales are projected to grow 6-8% to $105 billion. As per research firm Forrester, consumers will spend $95 billion this year, up 11% from last year, with mobile shopping playing a crucial role. ComScore expects online sales to jump 14% year over year to $70.06 billion for the full holiday season (November and December), outpacing the growth of brick-and-mortar retail sales. ETFs to Buy Given holiday optimism and a digital shopping boom, stocks and ETFs in the Internet and consumer space look poised for solid gains this month. Investors could tap this opportunity in a diversified way with the help of following ETFs. Each of these products have a solid Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy), and have retuned handsomely over the past 10 days, making them compelling for the holiday season (see all the Consumer Discretionary ETFs here ). Market Vectors Retail ETF (NYSEARCA: RTH ) This fund provides exposure to the retail segment of the broad consumer space by tracking the Market Vectors US Listed Retail 25 Index. It holds about 26 stocks in its basket, with AUM of $142.2 million, while the average daily volume is light at around 75,000 shares. Expense ratio came in at 0.35%. It is a large-cap centric fund, and is heavily concentrated on the top firm Amazon (NASDAQ: AMZN ) with 14.6% share, closely followed by Home Depot (NYSE: HD ) at 8.4%. Sector-wise, specialty retail occupies the top position with 29% share, followed by a double-digit allocation each to Internet and catalogue retail, hypermarkets, drug stores, and healthcare services. The product has added 3.8% over the past 10 days and has a Zacks ETF Rank of 1. SPDR S&P Retail ETF (NYSEARCA: XRT ) This product tracks the S&P Retail Select Industry Index, holding 104 securities in its basket. It is widely spread across each component, as none of these holds more than 1.36% of total assets. Small cap stocks dominate about two-thirds of the portfolio, while the rest have been split between the other two market cap levels. In terms of sector holdings, apparel retail takes the top spot with 21.7% share, while specialty stores, automotive retail, and Internet retail also have double-digit allocation each. XRT is the most popular and actively traded ETF in the retail space, with AUM of about $714 million and average daily volume of more than 4.1 million shares. It charges 35 bps in annual fees and has gained 3.3% over the past 10 days. The fund has a Zacks ETF Rank of 1. PowerShares Nasdaq Internet Portfolio ETF (NASDAQ: PNQI ) This fund follows the Nasdaq Internet Index, giving investors exposure to 94 Internet stocks. It is moderately concentrated on the top 10 holdings, with Amazon, Alphabet (NASDAQ: GOOGL ) and Facebook (NASDAQ: FB ) taking the top three spots in the basket, with at least 8% share each. Internet software and services makes for nearly 56% share in the basket, while Internet and catalog retail takes 39% share. The product has amassed $260.8 million in its asset base, while trades in lower volume of about 25,000 shares per day, on average. Expense ratio came in at 0.60%. PNQI added about 3% in the same time frame and has a Zacks ETF Rank of 2. PowerShares DWA Consumer Cyclicals Momentum Portfolio ETF (NYSEARCA: PEZ ) This product targets the broad consumer space by tracking the DWA Consumer Cyclicals Technical Leaders Index. It holds 38 stocks having positive relative strength (momentum) characteristics, with none holding more than 5.4% of assets. This approach results in a large cap tilt at 43%, followed by 33% in mid caps and the rest in small. About 29% of the portfolio is dominated by specialty retail, while hotel restaurants and leisure, textiles apparel and luxury goods, and airlines round off the next three positions with double-digit exposure each. The fund has managed $274.5 million in its asset base, while it trades in lower average daily volume of 57,000 shares. It charges 60 bps in annual fees, and has added about 1.7% over the past 10 days. The fund has a Zacks ETF Rank of 1. First Trust Consumer Discretionary AlphaDEX ETF (NYSEARCA: FXD ) This follows an AlphaDEX methodology and ranks stocks in the consumer space by various growth and value factors, eliminating the bottom-ranked 25% of stocks. This approach results in a basket of 129 stocks that are well spread out across each security, with none holding more than 1.7% of assets. About 50% of the portfolio is focused on mid cap securities, with specialty retail being the top sector, accounting for nearly one-fourth of the portfolio, closely followed by media (16%). FXD is one of the popular and liquid ETFs in the consumer discretionary space, with AUM of $2.4 billion and average daily volume of 462,000 shares per day. It charges a higher 63 bps in annual fees and has gained 1.5% over the past 10 days. The product has a Zacks ETF Rank of 1. Original Post