It’s difficult for investors to ignore China’s size and GDP growth rate. In the history of the world, no economy has made such a big leap in a short period as China.
However, there are some complexities surrounding China’s stock market that could make potential investors wary, while enticing opportunistic investors to jump in.
Let’s take a look at 4 such complexities:
1. China’s stock market is dominated by unsophisticated retail investors
Currently, the United States is still the world’s largest economy with a GDP of approximately $20.93 trillion.
The U.S. stock market (>200+ years) has a much longer history as compared to the Chinese market (30+ years).
There is no doubt that most global fund houses and investors would choose to invest more in the U.S. market rather than in emerging markets like China.
So, who’s fueling the Chinese stock market now?
Even Charlie Munger mentioned that investors in China “love to gamble in stocks”.
With more retail “gamblers” in the China market, it is no surprise that there is more volatility, and stocks tend not to trade with their fundamentals.
For example, in 2015, the Shanghai Composite Index soared 150% before crashing 30% in slightly more than 3 trading weeks. The surge followed by a melt-down had nothing to do with the underlying performance of the listed companies.
There is little doubt that China has one of the most volatile markets. Within their short 30+ years of existence, the Chinese stock market had already made the top rankings of both the best and the worst markets to invest in.
This might be caused by the ban on gambling and the stock market presented an alternative. The historical “Market Cap to GDP” for the Chinese market can range from a low of 35% to more than 600%!
Despite the gambling mentality and its resultant volatility, Charlie Munger remains bullish on China. He even made headlines for taking on positions in Alibaba during April 2021.
I covered why is Charlie Munger investing in China previously.
2. General Negative Perception of China
Even with the growth and advancements made in recent years, the perception of China is remains unfavorable.
A Global Attitudes survey done by PEW Research Center showed that many countries still hold negative views towards China, even though they agreed that China’s influence on the world stage has grown.
However, the survey found out that younger people aged 18 to 29 tend to have a more positive stance on China, as compared to those 50 and older.
This could be because of shocking scandals that had originated from China previously.
A memorable example is the milk scandal in 2008. during which 300,000 children were poisoned. Chinese suppliers had reportedly added melamine, a chemical used to make plastic, to powdered milk to artificially boost protein levels.
We’ve also seen companies like Luckin Coffee which were revealed to have inflated their sales numbers.
I believe that the world’s perception of China will take time to change, and it is slowly changing for the positive.
Fraudulent companies are not unique to China
Remember Enron and Wirecard?
How about the infamous Lehman Brothers?
Ever since the milk scandal in 2008, domestic milk powder maker China Feihe had gained traction in terms of sales and now hopes to capture a third of China’s baby milk market.
The President and Executive Director of China Feihe mentioned during an earnings release that “We expect to have at least a 30 % share in China’s infant formula market by 2023”.
China’s Latest Advancements
China had started working on its own digital currency since the year 2014. This is going to be the first digital yuan that will give Beijing the power to track spending in real-time. The best part is that it is not going to be linked to any global financial system.
Only recently, the U.S. has decided to press the case of digital dollar as central bank currency race heats up.
This is an example of China taking the lead in advancements instead of just playing catching up with other countries.
Another example of China’s advancement is their recent smooth landing of the Tianwen-1 probe on Mars. This makes China the third nation that has achieved such a feat, following Russia and U.S.
These are just two examples of the Chinese’s advancements.
We have not even touched on 5G.
Moreover, in the year 2016, China has made headlines breaking the world record on the number of patent applications.
3. Anti-Trust Saga
Antitrust laws were created to preserve competition among businesses and prevent any one business from dominating a single industry and building a monopoly.
The anti-trust issues have been a great challenge for many tech companies like Alibaba and Tencent in China. However, this is not exclusive to China.
The U.S. is also cracking down on their large tech companies like Facebook, Apple and Amazon on antitrust issues.
However, the same antitrust issue has a varying impact on the companies involved. The share prices of U.S. tech companies like Facebook, Apple, Amazon were barely affected by the news.
In contrast, the share prices of Chinese tech companies such as Alibaba, Tencent and Meituan took a huge hit.
Why is that so?
This phenomenon can be explained by the points mentioned above.
4. Lack of Government Stimulus
During this pandemic, many countries have introduced programs to help with the economy.
For example, in the U.S., many stimulus programs are initiated, resulting in trillions of dollars being released into the markets.
They have also lowered the interest rate to near zero, in order to continue supporting the economic recovery.
China is saving for a rainy day
While the U.S. is massively spending, China has been taking a more cautious approach.
During China’s high-level meeting “Two Sessions”, where their political elite gather once a year to reveal and discuss their annual goals, it was reported that Beijing had cut back on its financial support for the economy and are thinning off economic stimulus.
While the world has been increasing their debt levels, China is focusing on debt reductions instead!
China will also be cutting back the government’s special purpose bond issuance quota and will not be issuing additional “COVID-19” bonds (after selling 1 trillion yuan’s worth last year).
They have also kept their interest rate unchanged at around 3%. This is in stark contrast to the low interest rate in the U.S. This is despite China’s strong recovery post-pandemic.
Moreover, if we take a look at both countries’ foreign exchange reserves as of Jan 2020, U.S.’ FX reserves had $129 billion whereas China’s at $3.1 trillion. Both figures are denoted in USD.
With a conservative stance, China could have more resources to play around with, no matter how the pandemic unfolds.
Although good for its future, this move causes a lack of liquidity in the Chinese stock market, as there’ll be lesser money to stimulate the market.
China forecasted for more growth
IMF has raised China’s growth forecast to 8.4% for the year 2021.
However, this positive growth forecast alone is not able to help the China stock market.
Without liquidity in the market, good performance from a Chinese company will barely affect its share price.
In contrast, U.S. stock prices are soaring because of the earnings driven by the China market. Perhaps, that’s also why many Chinese companies are planning to list in the U.S. despite delisting threats.
Wrapping Up
With the recent antitrust regulations, investors are wary and worried about investing in China stocks.
My take is that the Chinese government is not out to kill their domestic big tech companies, but instead to create fair play among companies. This will push companies to innovate, thereby resulting in greater organic growth and better competitive space in the national and global arena.
It would probably be a short-term pain for a long-term gain.
However, not all is doom and gloom. At this point of writing, China stocks had jumped significantly since last July. Most of the movement is driven by overseas purchases via the stock connect.
Looking at the technicals, CSI 300 Index has broken its 100days moving average. This suggests a higher probability that the China stocks rally has more room to run.
In addition, the China market’s low correlation with major markets could benefit investors who are looking for diversification with risk-adjusted returns.
Macros are hard to predict. We will never be able to predict what the U.S. or China are planning, nor can we forecast further headwinds ahead;
- Will the U.S. be tapering off the stimulus after more got vaccinated and covid numbers being more manageable?
- Will the U.S. increase the interest rate which may then result in higher servicing debt? Or, would they carry out yield curve control?
- Could China suddenly decide to reduce its interest rates or Reserve Requirement Ratio (RRR)?
Nobody knows.
Even professional analysts tend to disagree.
There have been mixed views ranging from warnings such as investing in China could be like “catching a falling knife” to the contrarian view of potential ultra-loose policies and liquidity.
In my younger days, I’ve tried to predict the macros and had donated so much to the stock market.
Now, my strategy simply involves buying quality businesses and focusing on the fundamentals for the long term while seeking a balanced asset allocation.
I have learnt the hard way that trying to predict decisions made by other human beings or governments is simply too difficult.
Learning from Warren Buffet and Charlie Munger, I believed that certain principles are timeless and don’t change in investing even with decades to come.
If you see opportunities in China and would like to learn more about the China stock market and how to find profitable China Stocks, join Alvin at his next live webinar and learn:
- How to grow your portfolio by riding on China’s growth?
- Why we’re bullish on China stocks, and why you should have some exposure in them for crazy potential growth, in the coming years
- 3Cs: The unique framework designed for China investors
- Where to find unlimited China Stocks investing ideas?
- and more
Disclaimer: The article is purely my opinion based on my research/study. It does not constitute any form of financial, investment or advice. Just sharing my own experience as I have put my own money into the stock market for over 17 years. I am not a Chartered Financial Analyst (CFA) Charterholder and I do not have any finance-related qualifications.