A case of study: The Chinese stock market

Introduction

Over the last years the Chinese economy has been growing in a significant way. But if we look at some numbers and indicators, we can see that investors are underweighting Chinese stocks. Firstly, the MSCI all around country world index has 5,2% in China1, a very low number for being one of the biggest countries in the world. Besides, the growth domestic product of China(GDP)2, the monetary value of their output, represents only 16,8%.

But does it mean that Chinese assets could not be a good way of investment? If we look at the indicators in some sense, we are undervaluing Chinese bonds. In 2020 the shareholders who have invested in Chinese bonds, gained 41%, an Incredible performance. It was the result of the Chinese economy performing better than any developed economy in the world in the 2020. Nevertheless, the Chinese economy grew 2,3%, some of the weakest indexes of expansion3.

But to analyze, if Chinese stocks are underweight, we should look at the whole picture.

The cute face of investing in China

Everybody knows the controversy of the Chinese government, in regards to its data management. In contrast with the information showed by the Chinese government, the renowned organization called Capital Economics has shown that the economy grew close to 7% in the fourth quarter, up from 4.9% in the third quarter of the 2020. This is on an annualized basis.

Moreover, in the last decade, the Chinese economy has been growing in galloping steps. This can be explained by many indicators. For instance, its GDP has been increasing faster than many of the first world countries´ economy, and as result, it is getting to be a larger percentage of overall global GDP.

According to Moody ´s4, in 2010, China made only the 10% of the global GDP, Whereas the united states made 23,3%. Nonetheless, at the end of 2020, china has grown to 16,8% and the USA has shrunk to 22,2%. So China added 6,8%, the USA lost 1,1%.

To conclude, the Chinese economy has been growing with a great euphoria this last year. The main reason: Americans.

American impact on the Chinese market

With the pandemic, instead of spending their money for local consumption, Americans have been starting to spend their money in e-commerce agencies like Amazon, in which a big amounts of products are imported. Many of these goods are from Chinese industries.

During November, Chinese exports grew 21,1% in comparison to November of the 2019, and the exports to the USA grew 14,2% 5.

On the other hand, while the USA put some sanctions and taxes on China products because of the trade war, Americans have never stopped buying their products. Apart from this, some of the US companies have been starting to put some branch offices in China, and they have been starting to make some of their product in China. So the Chinese exports began to grow.

Pandemic management: Economic recovery

Furthermore, another fact that explains why the Chinese economy and the stock market has upswing in the 2020 was that they could quickly return to their normal life. Compared with other countries, the economy has not been affected by the coronavirus in a significant way.

Even though they are having 210 infected people per week, (the highest level since march of the 2020), compared to USA or Brazil, this number of infected is insignificant. They have thousands of new covid infected confirmed every day.

In contrast, as well as China started to have more control on the virus, the economy rebounded very strongly. Basically, one-third of the world workforce came back to work. Additionally, Chinese people began to increase their levels of savings. When the level of infections proceeded to decrease and the quarantine disappeared, the savings accumulation began to be spent on goods and services, which helped to upswing the economy very quickly.

But on the other hand, if we look at the stock market capitalization6 of Chinese stocks (included the stocks unlisted in Hong Kong), it represents a 67% relative to the GDP (the highest was 153% in 2007). If we compare that 67% to the USA, with its stock market capitalization, it has a 189% of the GDP (the highest in the 21st century). Even though China is the second largest country in the world, it represents 16,8% of the world economy and the stock market is 5,2% of the world (MSCI all-country world index). By the same token, the USA economy represents 22,3% of the global economy and it’s the 57% of the world stock market.

But after all, why do investors not prioritize investments in Chinese assets, if their economy is growing and they could have controlled the pandemic in a good way?

Political issues

The previous question can be answered by 3 details:

· External political issues: Trade war

· Valuations of the Chinese stocks market

· Long term political and economic challenges

On November 2020 Trump expressed some concerns about the addressing of the Chinese policies. Trump administration exposed that there was a national strategy in China called “Military-Civil fusion”. The CCP is compelling civilian Chinese companies to support military and intelligence activities, to enlarge the sides of its complex. Furthermore, the military companies were obtaining capital by selling securities in the USA. So as a result, in January 2021, the US treasury department listed out which securities support the military activities of the CCP, so they would not be allowed to be sold in the USA.

At the end of the last year, there were 35 companies selling securities in the American stocks markets (NYSE and NASDAQ). Consequently, the prices of the Chinese securities have dropped, because of the uncertainty among the shareholders about the implementation of this restrictive policy (they wanted to get rid of those securities).

To conclude with this point, the challenges on investment in China is that in some cases, the government could tell that you cannot invest in some companies, so as consequence, the prices of the shares could slump loudly.

A second concern is that the Chinese government has been pushing back some of the largest companies which represent a big proportion of the Chinese stock market. ANT group, which is an important enterprise founded by Jack Ma, it was expected to go public at a valuation of three hundred billion dollars. However, the CCP (Chinese Communist Party) shutdown the IPOs (Initial public offer)7, after Jack made a conference in Vancouver, in which he spoke badly about the CCP. Thus, the Chinese government put together some strong antitrust rules to put a limit to the power of these 10 companies (ANT group) and their stock sales off.

Another important detail is the indicators related to the Chinese stock market. In 1995, The price earning was 15 points, today is 20,02 and the most expensive has been 20,10 8. The average dividend yield is 2,4%, and also the cash flow is growing as time goes by 9.

To sum up, if you are thinking to put some allocations in China you have to watch out for some points. The Chinese government ideology, in which in some cases they are communist, as in social and political issues, but in economic matters, they are more liberals. Nonetheless, if they have to take some drastic measures, they will take them. So, it is very difficult to define the economy of China and to answer the question if we are underweighting Chinese stocks.

Bibliographic and footnotes

1 This means that only the 5,2 % of the shares of china have a participation in this index.

2 GDP ( gross domestic product) is the monetary value of all the finished goods and services made within a country.

3 (El País: January 18, 2021)

4 Moody ´s is an institution that classifies the different assets based on their level of risks and yields.

5 (Money for the rest of us: January 20, 2021)

6 the stock market capitalization is a measure of the sides of the stock market. It is calculated by taking the numbers of shares outstanding, and multiplying it to the price of those shares.

7 IPO (Initial public offer): It is a public offer in which the shares of a private company are launched for the first time into the stock market.

8 the price earning: It is the ratio between the company’s share price and the company’s earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.

PE=(SHARE PRICE)/(EARNING PER SHARE)

9 The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price.

DIVIDEND YIELD= (DIVIDENDS PER SHARE)/(SHARE PRICE)