Fragile China?

by | Aug 31, 2021 | Investing

While US equities are having a strong year with the S&P 500 up roughly 21.5%[1] including dividends since the first of January through the end of August, other markets are not performing nearly as well.  The emerging market stock index is up only 2.8% for the year, including dividends.[2]

While Covid concerns are a contributor to struggles, the big drag on the emerging market index is mainland China which represents 34% of the index.[3]   Just two Chinese companies – the internet behemoths Alibaba and Tencent – represent 8% of the index.[4]   The Hong Kong market, where many of the major Chinese companies trade, is down 3.3% in 2021.[5]

The Chinese government has been much more in heavy regulatory mode over free market mode this past year, and sectors like technology and education have been hit particularly hard.  President Xi Jinping’s mantra this year has been ‘common prosperity’ as the government seeks to deal with wealth and affordability disparities across the society as well as the influence and market dominance of firms like Alibaba and Tencent.

According to the Hong Kong based global bank HSBC, just 1% of the populations owns 30% of the country’s wealth; however, in absolute numbers and adjusted for living costs, the Chinese middle class, estimated by HSBC to be 340 million people, is double the size of the US middle class.[6]

The state-run capitalist system has brought hundreds of millions of Chinese out of poverty over the last four decades, but it also has created extraordinary wealth amongst a relative handful.  According to Forbes there are 698 Chinese billionaires, almost as many as the 724 in the US.[7]

HSBC believes China is on track to be the world’s largest economy in GDP terms within the decade.  It is hard to see China surpassing the US economy if it reverts back to a nationalized, command economy.  Is the long term forty-year trend of capital market development and entrepreneurship in China over?  Does it make good investment sense for a globally diversified equity program to fully divest from China?

The answer is probably no to both questions.  The more probable outcome is that Chinese regulators achieve their goals without destroying incentives to invest by both domestic and foreign sources of capital.   Markets have clearly been discounting the increased regulatory pressures.  Prices and valuations are down.   Maintaining a limited exposure to Chinese stocks through a broad emerging markets strategy as we currently do for our clients at Team Hewins is the appropriate and prudent course in our view.

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[1] Morningstar, data as of 8/31/2021

[2] Morningstar, data as of 8/31/2021

[3] Morningstar, data as of 8/31/2021

[4] Morningstar, data as of 8/31/2021, holdings data based on MSCI EM index tracking ETF.

[5] Morningstar, data as of 8/31/2021

[6] Liu, J. and Zhu, L., 2021. China will more than double millionaires by 2025. [online] Bloomberg.com. Available at: <https://www.bloomberg.com/news/articles/2021-05-21/china-will-more-than-double-millionaires-by-2025-hsbc-says> [Accessed 1 September 2021].

[7] Harper, J., 2021. Beijing now has more billionaires than any city. [online] BBC News. Available at: <https://www.bbc.com/news/business-56671638> [Accessed September 2021].

Team  Hewins,  LLC  (“Team  Hewins”)  is an SEC-registered investment adviser;  however,  such registration does not imply a certain level of skill or training, and no inference to the contrary should be made. We provide this information with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas.