If you’re looking for new markets or investment frontiers, you should not ignore China. It is already the second largest economy in the world, and likely to maintain its fast-pace growth for some time to come. China receives a lot of bad press focused on perceived obstacles to further growth, in many cases the reasons for its inevitable demise. Instead, we believe it is worth pondering the possibilities of a further rise yet that will naturally bring new investment opportunities to consider. Let’s get you started with some basic ideas that we will pursue further through upcoming articles on how to enter and focus on promising market or industry segments.
Entering the Reform Era in the late 1970s, China was dirt poor, at the time with GDP per capita less than 10% of the global average. In the 30 years following, GDP growth averaged 10% per annum and its economy expanded 15-fold. Despite a slowdown in growth rates in recent years (down to 6-8%) China is now the second largest economy in the world in nominal terms and its per capita income reached two-thirds the world average in PPP adjusted terms. In the coming years China will outperform the global economy and become the largest in nominal terms, which it already is in PPP terms.
This is probably the consensus view among forecasters, but optimism is often overshadowed, if not called into question entirely, by “doomsday” scenarios that get more attention in media than do statistical realities. At the “absurd” end of the spectrum are radical sceptics who question China’s growth record based on claims that the country’s economic statistics are “bogus”. A shade less absurd are “ideological” critics – neo-conservatives or market-fundamentalists predicting the collapse of China since they can’t fathom the success of an economic model under government guidance. There are sceptics in the mainstream as well. Not a day goes by that we do not hear a new prediction that China is about crash, collapse or burst, but history shows us that despite all of these claims of imminent collapse, China continues to prosper.
Let’s look at the last 20 years to set the historical record of these doomsday predictions. Before the Asian Crisis, China was believed to be very vulnerable due to its closed capital markets and fixed exchange rates; when the crisis hit, China was expected to suffer the most and take much longer to recover compared to other Asian economies. In reality, for these very reasons, China was largely shielded from the crisis and was able to quickly move on to reach greater heights. Less than a decade later China faced claims of an overheated economy, again sceptics called for bursting of bubbles and the collapse of the Chinese economy, but the government stepped in with the necessary restraint measures, and China continued to grow at a health rate.
The biggest test came with the 2008 crisis, one that left the global economy in ruin. China was claimed to have even more inflated asset bubbles that were sure to burst, and when global demand tumbled, China was supposed to suffer even more due to its dependence on exports. China responded with an aggressive stimulus package to maintain 9% growth in 2008, and, despite the collapse of its supposed growth engine, exports, the following year it pushed growth to 10% and in 2010 even above that. Now China is claimed to have lost its growth momentum, based on a slowdown from 6.7% growth in the 2nd quarter to 6.5% in the 3rd of 2018, and considered to be headed for an even deep recession than the rest of the world, predicted for 2019 or 2020.
If you’re still sceptical of China after it has consistently out-performed expectations, then by all means, stay away, or even bet on its demise. But if you care to understand the trends of the last 40 years and believe that the system is equipped to guide China into the ranks of the developed world at much higher income levels, then look into ways of investing in China, or at least finding instruments that give you an upside with China’s continuing rise. Unfortunately, finding those opportunities or instruments will take some effort.
Shanghai Stock Exchange is 6th largest in the world, behind New York, Nasdaq, Tokyo, London, and Euronext – followed by Hong Kong, Toronto, Bombay and BM&F (Brazil) in the top-10. Earlier in the year Shanghai ranked 4th behind NYSE, Nasdaq and Tokyo, thus has not had a particularly good year – SSE Composite has lost more than 25% from its year-high in January. China’s second largest exchange, Shenzhen, has not faired very well either, down 30% this year. Thus, this is not a bad time to get into Chinese stock markets; the general consensus is that both have bottomed out and are ready for a bounce.
However, this is more easily said than done; as a foreigner how do you buy China stocks or trade them? Chinese exchanges have not been fully open to foreigners, but entry is starting to ease up. Since 2002 Qualified Foreign Institutional Investors (QFIIs) have been allowed to trade on Shanghai and Shenzhen stock exchanges. Qualification rules are onerous (5-30 years in operation, $50 to $100 billion in funds, depending on type of investor) and repatriation is still difficult, but it is possible. They also face quotas, limited to only a small share of their equity base. Nevertheless, many institutional funds developed products, like baskets of Chinese stocks that clients could choose from, and this opened up windows for those looking for exposure to China.
The real opening up came with China-Hong Kong Stock Connect launched in 2014, allowing mainlanders to invest in Hong Kong (mostly China stocks anyway) and Hong Kong investors (together with foreigners due to the openness of that territory) to invest in Shanghai and Shenzhen stock exchanges. Restrictions still apply with minimum funds that investors must hold in trading accounts, as well as with daily overall limits on flows. Initially northbound flows were more significant, but soon the balance reversed; now this has become quite a significant conduit for foreign investment in Chinese stocks. Chinese appear to have lost their appetite for Hong Kong stocks while foreigners are attracted to low stock prices in China with this year’s slump.
This summer, Chinese authorities announced their intention to allow foreigners (from 62 countries) to open accounts with domestic brokerage houses to trade RMB denominated A-shares in both Shanghai and Shenzhen. The proposal is still subject to debate but looks like this move will open up a new era for foreign investment in China, but no doubt with limits and restrictions to prevent both sudden rushes of capital as well as speculative excesses. Part of the motivation behind this move is to cut out Hong Kong from the inbound flows; clearly there is too much red-tape and unnecessary fees going into Hong Kong pockets along the Stock Connect route. However, there is also genuine interest in opening Chinese companies to foreign investment, pleasing domestic interests and foreign critics alike.
Both the Stock Connect and the newly proposed window by the Chinese authorities are significant developments, but bear in mind that even the channels that developed behind QIIFs provide plenty of investment options to consider. There are Mutual Funds with Chinese companies in them, American Depository Receipts on US exchanges holding Chinese stocks (or rights to them) as well as options on Exchange Traded Products and indexes.
In many respects Chinese stocks have opened up to foreign ownership, albeit with constraints and difficulties, but beware of the risks that come with being exposed to individual company stocks when they become more accessible. You have to do considerable research into listed companies because reporting requirements are not yet what you might be used to, and perhaps even more important than company fundamentals are the markets and industry segments in which they function. This is a much more dynamic economy than you’d imagine, rapidly growing, restructuring, changing – be prepared to become a China-specialist. Also, bear in mind that 75-80% of trading on Chinese exchanges is retail-focused – you have to be able to relate to the sentiments and quirks of an unfamiliar crowd. However, as China continues to grow and open, there will be significant opportunities for those able to find their way into the market.