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China: Consumption is the citizen’s first duty

The new year – of the Gregorian calendar – began in China with a bang. For the second time in 2016 already, stock trade was suspended, on Jan. 7, in the dynamic country’s marketplaces. This sounds more significant than it actually is:

The leading stock exchanges in Shanghai and Shenzhen halted trading in the morning of Jan. 7 – just a few minutes after business had started.
The leading stock exchanges in Shanghai and Shenzhen halted trading in the morning of Jan. 7 – just a few minutes after business had started.

The news dominating the headlines in the short term will probably have no major impact in the long run. More importantly – for the Chinese economy in general and the local sporting goods industry in particular – are the long lasting factors. And they deserve particular attention.

The leading stock exchanges in Shanghai and Shenzhen halted trading in the morning of Jan. 7 – just a few minutes after business had started. The entire stock markets fell by more than 7 percent in value in a very short period of time. This action is due to new legislation in China since the beginning of this year: The laws now require that trading is stopped if the overall stock value slips by 7 percent.

In Western countries, one may be surprised at such regulatory methods to trim the market. The West, however, is not China. Interventionism has a long tradition there, and it is widely accepted in China that the government should step in to cool down a wildly developing economy. This applies to both monetary policy and the country’s stockmarkets.

Big impact of politics on markets

For an in-depth analysis of the current situation, it is important to not overreact to short-term effects. One of them was certainly North Korea’s nuclear test the previous day. At least for now, we would like to treat that event, however, as just another annoyance caused by China’s neighboring country of the kind we have seen before.

Observers believe that these events are accelerating Beijing’s process of re-thinking its policy towards North Korea. This could stabilize the region and, thus, improve the mood of investors between the Chinese capital and market places in Seoul and Tokyo.

Will the Chinese bubble burst?

Over the past few years, the Chinese administration was eager to do its utmost to keep highly speculative trading of stocks in check. This policy also included a general suspension of initial public offerings in 2013 and 2014.

This drove those Chinese companies with a high demand of financial resources almost crazy – including in the sporting goods industry. As reported, among them was outdoor chain Sanfo which arrived at the stock exchange last month. Altogether, the Chinese leadership has been trying by all appropriate means to prevent the burst of a potential stock trade bubble.

Tiananmen square in Peking
When it gets cold in Beijing: The big question is whether a rougher economic environment forces them to buy a no-name item rather than a branded product.

This is how the shares reacted

The fight against ruthless gambling at the stock exchanges is also turned against a negative evolution, i.e. when the shares are subjects to a landslide. Toread, as an example, is the leading outdoor brand in the country and simultaneously one of the most important retailers in the sector.

The mainly vertical structure of the company gives some leads to the general development both on the side of the vendors and in retail. During the last days between Dec. 31 and the suspension of trade, Toread’s share lost about 25 percent of its value. That may be nightmarish at the first sight, but a look at the share in the long-run allows a different interpretation.

The current value of Toread’s stock is very much on the level of 12 months ago. There was a terrific gain in value by more than 100 percent in May and June. In other words: Over one year, the share lost nothing, whatever may have happened in between. This corresponds very much with the big picture.

Bullish market in spring 2015

The ChiNext index of the Shenzhen Stock Exchange on which Toread has been listed since 2009 is in line with the evolution of the outdoor brand’s share. The comparison over the last 12 months shows that there was a bullish mood in Chinese stock trade.

This has to be understood in the context of the government having allowed IPO’s again. It was time for digging gold, but now the whole situation is where it actually belongs: back on earth again. Nothing less happened – but not more either.

Sportive newcomer remains unimpressed

How has it been going with outdoor retail chain Sanfo in the course of the recent events? The share of the Beijing-based retailer has remained unimpressed. Its value climbed steadily until trading was suspended on Jan. 7. Certainly, the share has had the advantage of a new paper whose offer started just on Dec. 9.

Sanfo: The charm of conservative business

Nonetheless, the tremendous growth did not come just like this if we look closer at the environment. Traditional retailing is rather a conservative investment model. It is safe to say that retail is more attractive in China than in the West due to the potential of geographic expansion inside the country.

But expansion costs a lot of money. Heng Zhang, Sanfo’s founder, made it clear from the start that a good part of the money deriving from the IPO would flow into the opening of new stores.

In other words: Investors will probably wait quite a while for a nice dividend. On top of that, there are other factors which are typical for the local sporting goods industry – and not all of them are encouraging. This includes stock excesses, hefty discounts and skyrocketing operational expenses in retail.

Skyline of Shanghai
The entire stock markets fell by more than 7 percent in value in a very short period of time.

At the end, it depends all on the bigger factors

In short, the events of the last troubled days should not let us neglect the bigger factors which will be by far more important in the long term:

  • Exports. The Chinese economy depends heavily on them. That’s why the administration is always very much concerned about the evolution of the local currency, the yuan renminbi. When the yuan gets too expensive, export-driven industries experience difficulties and face increase even fiercer completion from other manufacturing countries in East Asia. On Jan. 7, the euro was, at least for a while, worth more than 7 yuan – that has been the highest rate in years.
  • Loans. Quite a great deal of investments in China is financed through them. That’s particularly the case for the real estate sector where a big blow has been expected for a while. Constructing too much with little money ends in a bang sooner or later. We all know this from the West only too well.
  • Domestic consumption. The local sporting goods industry lives or dies with consumption – like anywhere else in the world. The two factors mentioned above do have their impact – directly or indirectly – on employment and buying power.

Executives in the Chinese sporting goods industry can do little about macro economic developments. What they can – and should – do is to contribute as much as they can to keeping the desirability of sporting goods at the highest level possible.

When the economy staggers and the buying power might even decrease, the utmost needs to be done to steer available household income into the right pockets. Turbulence at the stock exchange recedes swiftly, a reluctant consumer mood might last longer.

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