Why China’s economic rise isn’t a reason to invest

The most popular case for still investing China often boils down to the country’s continued economic rise.  

This year has seen many investors question the wisdom of investing in China owing to a regulatory crackdown there that’s hit tech stocks particularly hard. As well as the specific risk posed to companies targeted, the whole episode has left many investors with the sense that China is now too risky due to its unpredictable politics. For some, the whole episode is down to Xi Jinping and China turning its back on markets and capitalism, making China “uninvestable”.

But not everyone agrees. We’ve seen a large number of investors try to “buy the dip” following this summer’s big sell-off in Chinese shares. KraneShares CSI China Internet ETF USD (LSE:KWEB), for example, has seen consistent inflows. Meanwhile, big investors such as BlackRock have argued that Chinese equities should still have a place in investor’s portfolios.

The most popular case for still investing China often boils down to the country’s “rise”. China’s economy will eventually grow into the largest in the world, eclipsing the US, and, it is argued, will become the pre-eminent global power this century. Any investor would want exposure to that story.

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On the surface, this makes a lot of sense. However, according to numbers from the newsletter Policy Tensor, it is built on a faulty assumption.

The above case for investing in Chinese stocks assumes that China’s economic rise will be good for Chinese share prices and therefore investors. However, China’s rise and economic growth did not start yesterday. For several decades the big story of the global economy has been China’s rapid economic growth and transformation. But during those years, Chinese shares have not been particularly rewarding for investors.

The Policy Tensor newsletter first outlines that since the early 1990s, the US economy has grown three-fold, meaning it has tripled in size. In contrast, the Chinese economy has grown an incredible 26-fold. Yet over the same period of time, the US market has outperformed China. US shares have returned 6.8% per year, while Chinese shares have provided an annual return of just 4.6% per annum. Policy Tensor also notes that shares listed on the Shanghai Composite have been twice as volatile.

Surely, if fast economic growth rewards shareholders, investors in Chinese shares in the 1990s should have done better?

As Policy Tensor notes: “If future economic growth equalled investment opportunity, then there would’ve been no better time in history to invest in China than at the beginning of the Chinese take-off in the early-1990s. Yet, as we have seen, even as the Chinese economy grew by a factor of 26, a dollar invested in Chinese stocks only grew by a factor of 4.6. Meanwhile, even though the US economy only grew by a factor of 3 over the same period, a dollar invested in US stocks at market weights grew by a factor of 9.4.”

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The idea that investors need China exposure in their portfolio due to its economic rise, therefore, seems questionable. If rapid economic growth and transformation results in higher returns, investors in Chinese shares since the 1990s should have seen much bigger profits.

Policy Tensor concludes: “US investors should’ve paid dearly for missing out on Chinese exposure during the past 25 years. But they did not. This makes me very sceptical of the argument that US investors are dramatically underweight China. In order to buy the argument, we have to believe that the historical relationship between Chinese growth and investor returns will be overturned in the near future. But is there a good reason to expect a structural break in the Chinese regime of accumulation? There may well be. But I have yet to see any evidence of it.”