If you had invested $100 in the All Ordinaries Accumulation Index a year ago, you would have around $110 today. The same amount in the Chinese stock market would be worth just $60. That’s a sobering comparison when you consider that 12 months ago China was emerging from Covid, prompting optimistic forecasts of a robust consumer recovery, while America was still in the grip of above-target inflation and rising interest rates.
China has been a disappointment over longer time periods too. If you had invested in Chinese shares 20 years ago, soon after the country joined the World Trade Organisation, you would have doubled your initial investment. Not bad you might think until you compare that return with the four-fold increase in the value of the US stock market over the same period and the fact that a similar investment in the Indian stock market would have multiplied your investment ten times.
China continues to trip up investors who are determined to see a contrarian opportunity where other more cynical types perceive nothing more than an un-investable value trap. At the end of last year, Goldman Sachs said it expected the CSI 300 index of Shanghai and Shenzhen quoted shares to end 2024 at 4,200. After a dismal start to the year, that would now require a 30pc rebound from today’s level of around 3,200.
So, what are the cases for and against Chinese shares? If you are unscarred by the halving in its value since the February 2021 peak and considering whether to dip your toe in the world’s most unpopular stock market, is now the time to take the plunge?
The list of reasons to steer clear is not short. The Chinese consumer emerged from Covid with little apparent desire to go out and spend the money she had squirrelled away during her enforced confinement. That’s not hard to understand when you consider that youth unemployment stands at around 16pc. Meanwhile, the property sector, which might account for 30pc of GDP when you factor in related businesses like insurance, the sale of white goods and other ancillary services, continues to look like a slowly deflating bubble.
Demographics are unfavourable, with more deaths than births for a second consecutive year, suggesting that the Chinese population is both falling and ageing. There are twice as many people turning 60 each year as are being born. The so-called Japanification of China may be overstated, but the economy will need to become massively more productive to overcome its demographic headwinds in the years ahead.
That is before you have weighed up the unpredictability of China’s regulatory backdrop and the uncertainty surrounding the country’s frosty relations with much of the rest of the world, notably the US.
It is perhaps unsurprising that Beijing seems content to reset its growth ambitions to the current 5pc or so. Unsurprising too that China is resisting the temptation to throw good money after bad with the kinds of stimulus programmes that were the default in years gone by.
Given the performance of Chinese shares over the past year, it is perhaps no surprise also that overseas investors have voted with their feet. It is estimated that almost all the foreign money that flowed into China’s stock market in early 2023 had left again by the end of the year. Foreign purchases of Chinese stocks fell to an eight year low last year.
But what if the sentiment pendulum has swung too far? When the consensus is so clear about the reasons to steer clear of an investment, contrarian investors naturally start to get interested. What are the reasons to be positive about China?
Again, the list is lengthy. The first reason to be positive is that China finds itself at a very different point in the economic cycle than its rivals in the West. Growth has held up well in the US and Europe through the interest rate tightening cycle, but the risks of a slowdown or recession are now rising. China, meanwhile, faces a very different dynamic of improving confidence, supported by government stimulus of investment and consumption. Substantial household savings, accumulated during the pandemic, make an upswing in spending likely once confidence is restored.
Business confidence should improve as the regulatory environment eases. Policy is cyclical in China and Beijing looks increasingly inclined to shift its focus from stability to growth. A long-term goal to double GDP per capita can only be achieved with a robust private sector.
Chinese companies are innovative and have a competitive edge in many key sectors of the future such as electric vehicles. One important consequence of de-globalisation that overseas investors have tended not to focus on is an increasing preference among Chinese consumers for local brands and suppliers. Domestic companies are grabbing a bigger share of what remains one of the world’s biggest markets.
The final, and perhaps the most important, reason to be positive on China is that it has fallen so far out of favour with investors that its valuations stand at historically very low levels.
Priced at less than 10 times expected earnings, Chinese shares are roughly half the price of US ones and cheaper than equivalent stocks in Japan, Europe and the UK. They have rarely been cheaper on this measure in recent years. And this despite the earnings outlook being better than in most other large markets. A lot of bad news has been priced in.
Investing is always a balance between positives and negatives. In China, there are plenty of both. But the outlook may be better than sentiment suggests.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
