China Sentiment: The Cost of Impatience

Perhaps Warren Buffett’s greatest legacy to future generations will be his quotable investment wisdom. Among my favorites is this: “The stock market is a device for transferring money from the impatient to the patient.”

As a contrarian value investor, I’ve spent much of my career taking alpha from impatient people who sell quality assets at an abnormally high discount rate (code word for selling cheap). Investors understandably hate short-term losses from random stock price fluctuations—when they have chosen well and invested into a quality stock, they want immediate returns and validation. Unfortunately, short-term returns rely less on your investment acumen than on the whims of the stock market. Investors who impatiently monitor their portfolios worry constantly about what ultimately amounts to short-term noise—things which don’t matter to stock performance in the long run (e.g., election cycles, geo-politics, and babbling from the Federal Reserve).

By contrast, long-term returns—which can take years or even decades to manifest—rely more heavily on the quality of the companies held in your portfolio. Do your portfolio companies have strong fundamentals—a strong and seasoned management team, a technology or brand moat that protects it from imitators, or an attractive valuation given the assets in place and growth trajectory? If so, you can usually have confidence that returns will come over time. As Buffett also said, “If a business does well, the stock eventually follows.” But it often requires patience.

Buffett’s advice is especially important for those currently invested in China’s dismally performing markets. Despite recent headlines, there are many Chinese businesses performing extremely well. Yet, markets haven’t rewarded these fundamentally sound companies with higher valuations. In fact, these companies are being traded at historically cheap prices, especially on a relative basis. What is happening?

The answer is simple: negative sentiment.

There is no better proxy for “impatience” than “sentiment.” Impatient investors want immediate returns, and negative sentiment means those returns are unlikely to materialize in the short term. Unwilling to wait for value to emerge over time, they sell quality stocks to more patient investors—like me—on the cheap. In this way, the stock market works exactly as Buffett claimed—by transferring money from impatient investors to patient investors. I am a patient investment manager in large part because I am fortunate to work mostly for seasoned and well-diversified institutional asset owners. They have lived through many “sentiment” cycles. They have seen the retail army’s FOMO chase into the 90s Japan Bubble, the 2000 Tech Bubble, the 2007 Real Estate Bubble, and the 2019 Covid Meme Bubble. And, as each of these bull runs busted, turned into bear markets and neared their lows, they’ve seen these bold retail charges fully transform into fear-driven retreats. So most institutional asset owners know Buffett is right, even if the practice is so very hard to replicate—be greedy when others are fearful. Indeed, to invest well often requires one to reject their human instincts. My mentor and former business partner the great Rob Arnott is fond of saying, “In investing, what is profitable is rarely comfortable.”

Long term, I remain patiently confident in China’s growth story—as do many overseas investors who spend time in the country. China boasts a highly skilled workforce along with a vibrant tech sector buoyed by tailwinds of state support. Chinese households are getting wealthier, and economic growth is driven increasingly by domestic consumption. More importantly, the country boasts many great value stocks with strong fundamentals. These are powerful trends in the world’s second largest economy, and I’m convinced patient investors will benefit over time from a strategic and diversifying exposure to China’s long-term growth.

And because many investors globally, and especially those in China, are not patient, a long-term investor will be able to buy great Chinese growth companies at a heavy discount.

In the short term, a hard landing may still be coming for China. No one can know for sure when Beijing’s stimulus package will hit nor how big the package might be. Of course, much of this “hard landing” is already baked into the market. Indeed, prices reflect a deteriorating economy with no sign of recovery and a continuation of bumbled policy making—something that we have not seen since China liberalized its economy more than 40 years ago, even during Xi’s own first 10 years. However, impatient investors will continue responding to their fear by offloading or avoiding China exposure, which will depress valuation despite top-line and bottom-line beats coming from China’s blue-chip companies.

However, for patient investors, the case for staying the course in China remains robust. I remember my parents and their cohorts selling all their Taiwan assets in the 80s when Taiwan first crossed $10K in per capita GDP. At the time, many Taiwanese thought the low-cost export growth miracle was ending. This coincided with the power vacuum within the Kuomintang (KMT) [at the time the only legally allowed political party in Taiwan] as the military/political strong man, Chiang Ching-Kuo, was dying. Fear of an imminent Mainland invasion of Taiwan was thick in the air. Everyone who could afford to sell and run, indeed, sold and ran. Today, Taiwan is freer and more vibrant than ever. It’s per capita GDP has just crossed Japan, reaching ~$35,000. And its real estate and stock prices have reached record highs. Those who remained in Taiwan and/or remained invested in Taiwan—those who saw that a better future was possible and trusted in human grittiness to overcome adversity and bad times—have reaped enormous financial rewards.

In both life and investing, in tough times it can be hard to hold faith in the future while observing the present. But in the words of Mr. Buffett, “Someone is sitting in the shade today only because someone planted a tree a long time ago.” Let us not underestimate the heart and will of the entrepreneurs, investors, bureaucrats, and young people who are planting trees in China today. They see a future worth investing in. I believe in them. I hope to share in their success. I hope you’ll join us as well!

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