One Country, Many Reasons

From a Western perspective, many things about China are hard to understand.  For example, a communist government with a market economy, or the “one country, two systems” arrangement between Hong Kong and the mainland.

The Chinese stock market is even more confounding.   Quotes flash red on upticks and green on downticks.  There are more share classes than most people understand and the existence of onshore and offshore markets have led to a premium anomaly where like-shares trade at different prices.  How’s that for an efficient market hypothesis?

Right now uncertainty about big red is riding high, evident from its stock market performance last year.  In 2018 the Chinese market was off -30% from its February high, landing it squarely in a bear market.

Figure 1


There are many reasons behind the uncertainty.   Trade war, sluggish manufacturing, real estate/debt market concerns, all feeding into the ultimate fear that Chinese growth is slowing – an issue commonly called China’s “growth recession.”  It’s understandable why US investors are apprehensive about Chinese equities, every recession in US history has been accompanied by a massive stock market sell-off.

But people may be overreacting.   To begin with, China’s “growth recession” isn’t even really a recession.  It’s just a bad name for slowing growth, which is an issue the US has been dealing with for years.  What’s more, the slowing growth everyone fears just ticked in at 6.4%, down from 6.5% annualized real GDP.  We’re clawing to stay above 3% in the US.  Underlying fundamentals simply don’t look as bad as the headlines sound. Meanwhile, relative market valuation looks increasingly attractive for China versus the US.

Figure 2

Valuations based on FXI and SPY ETFs; Source: Trading Economics,, BCM

Yes, the US is the world’s economic bellwether, we’ve seen it all before and we even know what to expect.  But China is not the US, things are not only different but likely also misunderstood.  Just consider it’s one-party government, despite its shortcomings, it takes quick, decisive action, unencumbered by intermittent shutdowns.   This is not an argument about which approach is better, just pointing out different approaches can have different results.

Clearly, China has its problems and I don’t know if the Chinese stock market has bottomed.  Upcoming trade talks with the US could ignite a rally or further downside. What I do know is sentiment and expectations are low for Chinese equities at a time when their fundamentals look more attractive than other markets the consensus favor (like the US).

I think a long, patient position in the Chinese stock market at current prices or better will prove to be an excellent value.  Read more in our most recent investment letter “The Big Picture.” As always, do your due diligence.  If you take a position, build it on price weakness over time and don’t bite off more than you can stomach (afford to lose).

Victor K. Lai, CFA