How to invest in China (the easy way)
For long-term investors the balance of power between China and the West matters less than the continued growth of the global economy
Perhaps the most perplexing story of this year’s markets has been the disappointing performance of Chinese stocks, which had been expected to surge in the wake of ‘The Great Reopening’ that followed three years of Covid restrictions.
Far from outpacing the wider global market, which has rallied, however hesitantly, the MSCI China index is down 15% from its January peak. The reversal is instructive about the power of seductive narratives to tempt investors to depart from a simple diversified strategy that guarantees access to the gains of all of the world’s exchanges.
The spectacular rise of Chinese economy remains, of course, the most remarkable economic story of modern times. Since the country began to restructure its economy for integration with the wider world under Deng Xiaoping in 1978, its GDP has grown by an average of 9% a year. Today China has the second largest economy in the world, accounting for almost a fifth of global output, giving it the power to exert a profound geopolitical as well as economic influence.
And the raw facts are only part of the story. China fascinates, its engineering and technological prowess generating waves of speculation about the country’s unique capacity to shape the future.
Chinese futurism
Most intriguingly, perhaps, is the Chinese space programme, which evokes something of the mystery of the Soviet space programme at the height of the Cold War. In his new book The Future of Geography, Tim Marshall charts China’s ‘techno-nationalist’ course under President Xi Jinping, during which ‘the Communist Party has started to use space as a way to signal China’s status as a military, technological and economic leader.’ A ‘Perspective’ issued on the country’s extraterrestrial ventures last year was redolent of old Soviet rhetoric, declaring the Party’s ‘eternal dream’ to ’explore the vast cosmos, develop the space industry and build China into a space power’.
And the programme’s bold progress over the past few years gives those claims weight. China’s satellite industry is at least as advanced as that of the US. The country has its own space station, the Tiangong 2, operated entirely by itself (the International Space Station requires multi-national collaboration). China landed the first spacecraft on the far side of the Moon in 2019, and deployed a rover on Mars two years later. It has credible plans for a permanent lunar base for mining the Moon’s potential riches. And, while the West scrambles to develop its technical expertise China continues to increase its formidable force of highly skilled engineers: the Beijing Aeronautical Institute alone currently has 23,000 students.
China’s powerful brand of futurism, together with its sheer economic heft, offers fund managers endless opportunities for spinning investment stories about the rise and rise of the enigmatic East. The constellation of funds tracking the Chinese economy continues to grow. KraneShares, whose CSI China Internet ETF soared through the tech boom, this year issued the SSE Star Market 50 Index UCITS ETF, the first to offer exposure to the Shanghai Stock Exchange Science and Technology Innovation Board, the so-called ‘STAR market’ designed to as China’s response to NASDAQ. The newly issued iShares MSCI China A UCITS and Invesco S&P China A 300 Swap UCITS ETFs offer retail exposure to companies listed on China’s Shanghai and Shenzhen exchanges, previously accessible only to select overseas institutional investors. Other new funds seek to track China’s massive climate transition market, estimated to be worth $250bn, more than six times the combined value of the next six largest in its peer group.
The dragon flies low(er)
China’s rapid ascension and undoubted technological firepower warrant the close attention of all investors. But this year’s dispiriting performance is a sobering reminder that it too is subject to the laws of economic gravity, and the remorseless ebb and flow of market sentiment.
Investors sunk record funds into China in January after Xi yielded to public pressure and eased Covid restrictions late last year. But Chinese stocks have weighed down rather than outpaced the wider market. The benchmark CSI 300 index is below 12 times forward earnings, a steep discount to global peers and below its 10-year average. Chinese stocks are being offloaded as far as they were acquired, with $659m sold in April and $1.7bn last month. Shares of giant ecommerce groups Alibaba and Pinduoduo are down more than 30% from earlier this year.
The sell-off reflects concerns that the failure of the Chinese economy to find its old groove following the lockdowns might indicate a deeper malaise. In a no-holds commentary for the Financial Times, Rockefeller International chair Ruchir Sharma argued that there ‘has never been a bigger disconnect, in my experience, between some of the rosier investment bank views on China and the dim reality on the ground.’
This year’s disappointing figures indicate a contraction in manufacturing activity, falling property investment and industrial profits, and, perhaps most surprisingly, the failure of the lifting of lockdown restrictions to spark retail sales. Chinese consumers continue to struggle with a debt service burden that has doubled in the past decade to 30% of disposable income, three times higher than that in the US. In Sharma’s assessment: ‘While analysts may have little to lose from rosy forecasts, the rest of us do. “Boomy” chatter has contributed to investors’ loss of hundreds of billions of dollars in China in just the past four months … It is time to expose this charade before the fallout gets worse.’ There are also signs the economy is finally struggling to generate new jobs, JPMorgan chair Jamie Dimon describing the country’s youth unemployment figures, which surged to more than 20% in April, as ‘scary.’
In their recent book Danger Zone: The Coming Conflict with China, Hal Brands and Michael Beckley speculate that we are witnessing ‘Peak China’, as the factors that drove the country’s extraordinary growth now begin to work against it. Famed for its seeming inexhaustible army of skilled workers, China’s working-age population has now been declining for about a decade, with UN forecasts suggesting that it could fall by more than a quarter by 2050. Further productivity gains are threatened by the need to devote more resources to care for the elderly.
Returns to new investment are declining as it becomes more challenging to identify where funds might be usefully deployed: expensive high-speed rail lines linking the country’s vast western hinterlands to the powerhouse cities to the east will yield less spectacular gains than those that connected Beijing and Shanghai. And rising government debt has restrained the state’s ability to fund new projects.
Escalating geopolitical tensions are choking international investment, with many foreign firms diversifying supply chains away from China. The US government has restricted Beijing’s access to world markets, notably by banning the export of certain semiconductors and other technologies to Chinese firms. And the President’s authoritarian inclinations, notably the crackdown on digital entrepreneurs, may be choking the country’s capacity to innovate. In the assessment of The Economist, Xi’s China ‘now prizes security over prosperity, greatness over growth, sturdy self-reliance over the filigreed interdependence that distinguished China’s past economic success.’
The magazine notes the shift in sentiment among forecasters that had once predicted that the country’s GDP would rapidly eclipse that of the US later this century. Goldman Sachs, for example, which had expected the size of China’s economy to overtake America by 2026 and become more than 50% bigger by mid-century, now suggests it will surpass that of the US only in 2025, and never by more than 15%. Capital Economics is more sceptical still, arguing China won’t even achieve parity with the US, peaking at 90% of American GDP in 2035.
As China has grown it has become fashionable to contrast its ‘inevitable rise’ with American ‘decline’. But as China’s troubles have gathered, the US economy has continued to perform strongly. Another Economist feature argues that ‘America remains the world’s richest, most productive and most innovative big economy. By an impressive number of measures, it is leaving its peers ever further in the dust.’
The magazine lists some startling facts that go against the grain of much investment commentary of the past few years. The US now accounts for 58% of the G7’s GDP, compared with 40% in 1990. Back then, America accounted for a quarter of the world’s output, a share which, China’s gains notwithstanding, remains unchanged. The US has nearly a third more workers than in 1990, compared with a tenth in western Europe and Japan, and they are better paid: remarkably, average incomes in Mississippi, America’s poorest state, exceed $50,000, higher than those in France. American firms own more than a fifth of patents registered abroad, more than China and Germany put together, and all of the five biggest corporate sources of research and development are American. It all means that those who have kept faith in the US have been rewarded: ‘Investors who put $100 into the S&P 500 in 1990 would have more than $2,000 today, four times what they would have earned had they invested elsewhere in the rich world.’
The wider picture
So, should investors stay clear of China and keep faith with the proven record of the US and other Western economies? No. The lesson is surely that the ebb and flow of the world economy cannot be predicted with any certainty, and the wisest course is to stay the course with a diversified fund tracking China, the US, and the rest of the world.
The US and China have particular strengths and weaknesses. Xi could depart from the authoritarian path he has so far followed, opening the Chinese economy up to further liberalisation, triggering a new round of rapid growth. The prospects for the US could darken under another Trump presidency. We simply don’t know what is going to happen in the future. Investors should be content to hold proportionate positions in both economies, accessible through a simple tracker fund.
In a measured assessment Martin Wolf puts the rise of China in context, describing it as ‘a global rebalancing, as the historically brief, but world-changing, domination over humanity of Europe and its colonial progeny dwindles away.’ Wolf notes that in 1820 Asia generated 61% of world output, and western Europe only 25%. By 1950, the Asian share had collapsed to 20% while western Europe’s had reached 26%. But by 2018 western Europe’s share was down to 15%, while Asia’s had recovered to 48%. The big story is not that of American decline and a new era of Eastern supremacy, but ‘the recovery of what we call Asia, led by east Asia, from its steep relative economic decline in the 19th and early 20th centuries.’
The reassertion of Chinese power does not need to come at the expense of the US. If geopolitical difficulties can be managed the prospect is a stronger world economy that benefits all. We don’t know what the future balance of power between China and the West will be. And from an investor’s point of view it doesn’t matter. All that is necessary is to hold both markets, and benefit from rising prosperity in both spheres. China’s story is a fascinating one, but one that investors can watch from the sidelines without buying into entertaining, but speculative, ‘rise-and-fall’ narratives.
Photo by Harrison Qi on Unsplash.
