Explore the surprising disconnect between China’s booming economy and its underperforming stock market, and discover where the next investment opportunities lie.
Topics covered include:
- How badly has China’s stock market performed except for one remarkable decade
- What are the economic and governance factors that contributed to the underperformance
- Why it’s too soon to write off China despite the structural headwinds
- What are the factors that contribute to economic growth and a robust stock market, and which emerging market countries display those factors
- What are some ETFs to invest in countries with favorable economic tailwinds
Show Notes
State-Owned Enterprises Going Public: The Case of China by Xiaozu Wang, et al.—SSRN
A Model of China’s State Capitalism by Xi Li, et al.—SSRN
Has China given up on state-owned enterprise reform? by Nicholas Borst—The Interpreter
China Regulator’s New Slogan Fuels Buying Spree in State Firms by Bloomberg News—Bloomberg
Investors sour on Beijing’s bid to boost state-owned enterprises by Sun Yu—The Financial Times
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 445. It’s titled, “From Boom to Bust: Why China Stocks Lagged Behind its Economy, and Where to Invest Next.”
We have recently been working on adding cyclically adjusted price-to-earnings ratios or Shiller P/Es to Asset Camp, our stock index reporting service. As part of the process, I’ve been working on the formulas to add to our database and ended up spending some time studying the long-term performance of the Chinese stock market and the underlying drivers.
Chinese Stock Market Underperformance
I was shocked to see how poorly the Chinese stock market has performed since the Stock Exchange was reestablished. The original stock exchange in China is the Shanghai Stock Exchange, but it was closed for decades, from 1949 when the People’s Republic of China was founded, up until November 1990, when it was officially reestablished. Around the same time, the Shenzhen Stock Exchange opened in December 1990.
The first Chinese stock index that I’m aware of, or at least have data to, is the MSCI China index. It began on December 31st, 1992. At the time, beginning of 1993, there were 53 publicly listed firms trading on either the Shanghai or Shenzhen Stock Exchange. When they were reestablished, in the case of the Shanghai Index, or brand new, the Shenzen Index, in 1990, there was only 10 listings. Now, by 1992, there were 53 listings. That’s the starting point.
Over the next 30.6 years, through last Friday, August 18th, 2023, the MSCI China Index has returned 0.7% annualized in Chinese yuan, and 0.6% annualized in US dollars. Less than 1% annualized return. That compares to 8.4% for the global stock market in local currencies, and 8.1% in US dollars. That would be the MSCI All Country World Index. The US stock market, over that 30-year period, has returned 10% annualized.
China’s Economic Growth
It’s absolutely amazing when you consider Chinese economic output, its GDP grew from 1992 —it was at $427 billion, to $18.1 trillion today. The economy is 42 times larger; the second-largest economy in the world. The overall size of the stock market, as measured by market capitalization, which is the number of shares outstanding times the price. There are way more stocks outstanding now, and so the size of the stock market went from less than $100 billion in the early 1990s, to $12 trillion today.
Yet, investing in a Chinese stock index mutual fund or ETF has been incredibly disappointing, except for one amazing decade, from 2001 to 2011. And this was the time that I was overweight China by way of being overweight emerging markets, both in my personal portfolio, as well as in the institutional accounts that we managed at my old firm, FEG Advisors. That 10-year period was amazing because China outperformed the US stock market by over 10% annualized.
When we invest in an index mutual fund or ETF, we’re investing in a basket of stocks that tracks some segment of the market. And the factors that drive those stock returns over time are their earnings. Are their earnings growing, and what percent of those earnings are being paid out in dividends? So if the earnings are growing, then the dividend is growing, and so the long-term driver of returns is the dividend yield plus the earnings growth, plus any change in valuations as investors choose to either pay more or less for those dividends and earnings.
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