Guild Investment Management, Executive Summary, June 1, 2017

Executive Summary

 

1.  China’s e-commerce and social media firms are beating the developed world at the innovation game.  China’s development trajectory over the past three decades has been almost unimaginably disruptive, pulling migrant workers to China’s cities and creating a huge cohort of millennials who exist uneasily between the Confucian world of their grandparents and the liberal, Western-leaning trends of their peers.  It also created a population without the social connections that supported friendship and courtship in old rural life.  But these dislocations were happening at the same time that the mobile internet was exploding in China, and the effect has been intense innovation in e-commerce and social media.  Now these trends are meeting in a phenomenon that could be called “social commerce,” and Chinese internet firms are leading the way on a path that developed-world tech giants will likely follow, with novel platform integrations and revenue streams.  For the first time, Chinese innovators are visibly pulling ahead of their developed-world peers.

2.  Market summary. 
June has arrived, and with it a concern that some of the current enthusiasm for tech stocks could diminish.  We believe that corrections, if they occur, will be buying opportunities for the disruptive tech leaders.  We are expecting a normal choppy summer which will lead to some short-term stock price corrections and then higher prices for stocks — especially if some form of corporate tax cut is passed in late 2017 or early 2018.  Any infrastructure bill would be another welcome positive for U.S. stocks; many believe that such a bill could pass in early 2018, so that members of Congress from both parties could point to it during their 2018 Congressional races.  We remain bullish on Europe, which remains inexpensive; and we expect further appreciation as investors realize that the fear of deflation is disappearing.  European GDP is expanding, and confidence is returning to the continent.   We remain bullish on emerging markets that do not rely heavily on commodities for export — this means on countries like Taiwan, India, Malaysia, and Vietnam, as well as some eastern European countries.  Gold is moving erratically higher; currently at $1270, we see it moving slowly higher on a technical basis to the next target of $1282/oz.

 

Social Commerce, Live Streaming, and Virtual Goods:  Chinese E-Commerce Innovation Pulls Ahead


Since its economy began to be opened in earnest in the 1990s, China has undergone a transformation so radical that it defies easy description — one we’ve often written about in these pages.  From many perspectives, the Chinese achievement is astonishing: China’s embrace of major elements of market-based economics has lifted hundreds of millions of people out of poverty, even though it has been accompanied by a political regime that shuns Western notions of democratic governance.  (Economic and political liberty don’t always occur together as they have in Europe, the United States, and Japan.)

We often express the “Chinese miracle” in the terms of macroeconomics: GDP growth, urbanization, productivity growth, manufacturing exports, infrastructure investment, financial instability and shadow banking, and so on.  However, underneath all the macroeconomic data are human stories.  Hundreds of millions of Chinese have migrated from the rural countryside to the cities over the past several decades — perhaps the largest migration of humans (or any other animals) in the history of the world.

This migration has ongoing effects every year, when migrants return home to their villages to celebrate the Chinese New Year with their families.  The clash of cultures is intense: urban Chinese millennials, even those with recent rural roots, are now inhabitants of a social and cultural world so different from the Confucian universe of their grandparents that when you grasp the scale and pace of change, you marvel that the distance can still be bridged at all.  China’s most-developed coastal cities are at the development level of southern Europe; the least-developed regions of inland China are not far above the level of some African economies.  (For an appreciation of this tension, we recommend that readers watch the acclaimed 2010 documentary about migrant factory workers, Last Train Home.)

Controlling the Stress to Protect Stability

The development divide is a matter of profound concern for the Chinese authorities, who are of course alert to the possibility that these tensions will lead to political unrest and dissatisfaction — unless continued economic growth keeps bringing less-developed Chinese cities and regions into the fold of the rising middle class.  (That concern is undoubtedly behind the fateful choice that the authorities seem to have made, to permit the continued inflation of debt bubbles which we believe will cause a crash in the Chinese financial system in the next three to four years.  It’s also behind the government’s massive “One Belt, One Road” program to build out infrastructure throughout the country’s poor interior.)

Of course, the Chinese government is doing its best to triage the social dislocation caused by the epic migration from countryside to city, the weakening and breaking of family bonds that have formed the basis of Chinese society for thousands of years, and the loss of the social networks that had supported migrants while they were still in the village.  But while the government thinks about macro policies, China’s new urban dwellers are busy using the tools they have at their disposal to recreate social connections for themselves: and that means social media and e-commerce.

 

 

The World of Social Commerce: A Response to Radical Social Disruption

The period of breakneck economic development, and the severe social and cultural disruption that has accompanied it, is also the period which has seen the arrival of the internet and mobile internet access.  This is the fundamental reason why the social and economic effects of the internet have shown different, more intense dynamics in China than they have in many other societies, particularly in the developed West.  We will be bold to say that it is also the reason why, when you look under the hood, e-commerce innovation has been even more remarkable in China than it has in the developed world.

Specifically, in China, cultural dislocation and the simultaneous arrival of the internet has helped create a new phenomenon: social commerce.  Consulting firm Concept M notes:

“The young generations in China are experiencing a program of cultural transformation.  On the one hand they are still tied to the conventions of obedience towards their parents and the institutions, while on the other they are seeking their own identity, based on individualist values following Western influences.  Within the protected space of extended expeditions through online stores, young people are accordingly pulling together pieces of their new Western-oriented identity.  For them, online e-commerce worlds function like dream worlds, making it possible for them to catapult out of everyday life and leave behind the dull reality of cramped living conditions and conflicts in the family and working environment.  As 90% of e-commerce is done on the smartphone, it is also a constant companion during the day and a constantly available refuge.”

Major Chinese e-commerce companies are pioneering this thorough a synthesis of social media and e-commerce.  This is creating a world in which millennial Chinese urbanites can reinforce their emerging identity as Western-looking global consumers, while simultaneously allowing them to recreate in the virtual world something of the social connectivity they would have had in a rural village.

Alibaba’s Taobao platform, for example [NYSE: BABA] functions as a kind of synthesis of Facebook [NASDAQ: FB] and Amazon [NASDAQ: AMZN].  (Unlike AMZN, BABA’s wares are exclusively offered by third parties, with BABA providing the platform and associated services to merchants.)  Taobao integrates social functions, with buyers able to interact with other shoppers and with peers who have recommended products in real time while they browse.  It’s like having a virtual souk — or marketplace — in your pocket.

Chinese e-commerce firms have found that the deep integration of social media into their platforms brings users to their sites much more frequently and keeps them there longer.  It also makes them buy more.  In the quarter reported in December, BABA increased the number of active mobile buyers by 25% to 493 million, with revenues up 54% in the same period.  These users visit the Taobao mall six to seven times a day for a total of 30 minutes.  HSBC analyst Chi Tsan notes:

“I doubt an average user would open the AMZN app six or seven times a day, because the shops there aren’t social…  But BABA has a very broad strategy.  They view themselves not only as a marketing place.  They view themselves as a place where people spend time.”

Another major company making this deep integration is Tencent [Hong Kong: 0700] through its WeChat app, a standalone chat application which has 846 million monthly active users (Snapchat [NYSE: SNAP] has about 160 million).  As we reported last week, Tencent is using WeChat to drive business to its lucrative gaming franchise.  However, it is also using another avenue: video livestreaming.

Livestreaming Takes Off in China, and Boy Do They Know How to Monetize It

Livestreaming is a phenomenon that exploded in China in 2016.  You may be familiar with the phenomena of “Instragram personalities” or “social media influencers.”  These are figures who acquire dedicated followers of their social media feeds — usually in some particular niche of fashion, music, design, or pop culture.  Being such an influencer has become quite lucrative, since brands are willing to pay a premium for their products to be featured prominently in such influencers’ feeds.  First, they usually reach the eyes of coveted demographic groups; and second, such apparently organic product placement is perceived by consumers as being more authentic and trustworthy than traditional advertising.

Times are about to get tough for influencers, though, with the Federal Trade Commission (FTC) watching very closely how social media personalities disclose their relationship with brands, and more stringent enforcement possibly in the works.  No such problems in China.  Live videostreaming by influencers in China — for example, on WeChat’s livestream platform — includes integrated e-commerce built into the app itself.  It’s as if a Facebook live feed from your favorite celebrity discussing some product they love had an e-commerce shopping cart right next to the video.  BABA claims to have a 32% conversion rate: if a live stream in which a product gets plugged is seen by a million viewers, 320,000 items get put in shopping carts.

Virtual Goods

An even more mind-stretching trend has proved to be a boon for location-based social network MoMo [NASDAQ:  MOMO].  MOMO launched several years ago as an open, location-based social network that almost immediately got branded as the “Chinese Tinder.”  Despite the risqué beginning (especially from the perspective of traditional Chinese mores) they obviously helped fulfill a real need for migrants and socially dislocated urbanites to find nearby potential friends with common interests.

MOMO borrowed a page from another, more traditional social network, YY.com [NASDAQ:  YY], which had pioneered livestream video and its monetization with “virtual gifts.”  When your favorite personality is livestreaming — maybe a fashionista offering advice, or a performer playing music — you can pay real-world cash to send them virtual gifts — a bouquet of flowers, for example.  Both performers and other users see and can interact with these gifts in real time.  The more personalized and elaborate the gift, the more expensive — with the platform and the content creator both getting a cut.  Last year MOMO opened its livestream platform to all users, rather than just to curated performers and personalities, in a bid to widen its appeal and attract more users.  These virtual goods are proving to be potent revenue generators for many of China’s social commerce companies.  They parallel the in-game purchases we mentioned last week, in which players of games like Tencent’s Clash of Clans can fork out hard cash for virtual items to give them an edge in gameplay.  Do not underestimate the extent to which gamers and social platform users will pay real-world cash for virtual goods.  (If you are tempted, we recommend studying MOMO’s most recent annual report to shareholders, which showed revenues grow more than 300% year on year, driven largely by sales of virtual goods in its livestream services.)

U.S. social media and e-commerce companies may well move in the same direction.  SNAP recently launched “World Lenses,” an expansion of the playful photo mods that can add dog ears or rainbow tongues to users’ selfies.  “World Lenses” will allow users to place 3D objects in their snaps.  For now, it’ll be fun things like smiling rainbows…  But when we look at the virtual gift trend emerging in China, we can easily imagine how lucrative it could be for SNAP to offer branded or personalized World Lenses to consumers.  It sounds absurd, and perhaps it is absurd from a philosophical perspective: but the evolving landscape of social media doesn’t care much about our opinion.

Social Commerce:  The Chinese Innovation

For now, U.S. e-commerce and social media look decidedly backward compared to the direction being taken by China’s internet innovators, and we believe that ultimately they will be catching up.  In this case, necessity was the mother of invention: China’s epic and severely disruptive decades of development helped leapfrog them into a world where virtual interaction could in some way replicate many of the social and economic functions of a village market.  American consumers don’t have the same pressures — but the strength of the model may prove to be irresistible.  The critical factor for success will be whether platforms can constantly develop innovative features that will attract and retain consistent users.  

Investment implications:  Because of the relatively small and underdeveloped character of Chinese equity markets, these markets, by and large, still behave with scant reference to company fundamentals, and much more reference to sentiment and momentum created by Chinese government pronouncements — which is frustrating for investors who see a powerful market trend emerging in China and want to take advantage of it.  We believe that many of the e-commerce and social media companies mentioned above will succeed and thrive, although there may soon be a period of consolidation in which smaller companies are absorbed by larger competitors.  A further complication is the questionable trustworthiness of Chinese financial reporting, though the larger and more established firms are somewhat more reliable in this regard.  Investors who want exposure to the theme of Chinese social commerce should bear all these factors in mind, and trade these securities only when market conditions are showing favorable public and government attitudes towards equities.

With that said, these themes also merit attention from investors who are watching e-commerce and social media trends in the developed world.  For example, although we believe SNAP is currently excessively valued, the company could find novel revenue streams, such as virtual gifts, that investors are not currently incorporating into their models.  We believe that both of the trends discussed above — social commerce and virtual gifts — have the potential to play transformative roles in established developed-world e-commerce and social media companies.

Market Summary

 

The U.S. Market

June has arrived, and with it a concern that some of the current enthusiasm for tech stocks could diminish.  We believe that corrections, if they occur, will be buying opportunities for the disruptive tech leaders such as Google [NASDAQ:  GOOG], Amazon [NASDAQ: AMZN], Facebook [NASDAQ: FB], and Apple [NASDAQ:  AAPL].  We are expecting a normal choppy summer which will lead to some short-term stock price corrections and then higher prices for stocks — especially if some form of corporate tax cut is passed in late 2017 or early 2018.  [Note: GIM owns GOOG, AMZN, FB, and AAPL for some clients.]

Any bill which began the process of repairing U.S. infrastructure would be another welcome positive for U.S. stocks; many believe that such a bill could pass in early 2018, so that members of Congress from both parties could point to it during their 2018 Congressional races.  If an infrastructure bill passes, it will probably be about $200 billion of Federal money over 10 years, supplemented by about $800 billion in private-sector funding, which would earn returns from tolls and other sources of income.

Europe

We remain bullish on Europe, which remains inexpensive; and we expect further appreciation as investors realize that the fear of deflation is disappearing.  European GDP is expanding, and confidence is returning to the continent.  We recommend hedging your European portfolio for the effect of a rising U.S. dollar.

Emerging Markets

We remain bullish on emerging markets that do not rely heavily on commodities for export — this means on countries like Taiwan, India, Malaysia, and Vietnam, as well as some eastern European countries.  In this part of the world it is hard to hedge against a rise in the dollar, so we will exit these positions if the dollar begins to rise in a steady manner.

Gold

Gold is moving erratically higher; currently at $1270, we see it moving slowly higher on a technical basis to the next target of $1282/oz.

Thanks for listening; we welcome your calls and questions.

 

Tim Shirata
Executive Vice President
Guild Investment Management, Inc.

12400 Wilshire Blvd. Suite 1080
Los Angeles, CA 90025
Tel: (310) 826-8600 Fax: (310)826-8611
email: tshirata@guildinvestment.com
http://www.guildinvestment.com

 

 

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