Han Dieperink: Investing in China Pays Off Again
Han Dieperink: Investing in China Pays Off Again
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
In recent years, there has been hardly any investment in Chinese stocks. This seems unjustified, as the Chinese economy is increasingly resembling other developed economies, particularly Japan.
Where prices in China were comparable to Western prices five years ago, China—also for tourists—has become much cheaper since then. This is because there has been no inflation in those five years, but rather deflation. Similarly, Japan was an expensive country before its two lost decades, but now it is teeming with tourists, partly because Japan is so cheap.
Moreover, the Chinese economy is no longer growing by 10% every year. The Chinese now realize that things can also go worse. Many investors have avoided China in recent years, but this is likely unjustified.
1) Political Situation
The relationship between China and the United States deteriorated significantly during Donald Trump’s first presidency. While Joe Biden has not adopted any other part of Trump’s policies, he has continued Trump’s approach to China. Biden has even been stricter than Trump ever was, despite having gotten to know Xi Jinping well when he was Vice President under Barack Obama.
Xi has visited the U.S. seven times, and Obama visited China three times. Nevertheless, the Chinese prefer to do business with Trump rather than the Democrats. At least Trump doesn’t fuss about Tibet, the Uyghurs, or Hong Kong, whereas the Democrats do. Kamala Harris hardly talks about international politics, but the general line of the Democrats is to divide the world into a group of democratic countries and a group of countries that are not.
America First
Trump views the world more from an ‘America First’ perspective and is much less principled. In his current campaign, Trump stated that Chinese automakers can sell their products to American consumers, provided those cars are produced in the United States. This is a solution similar to that in the 1980s when Japan was still in the process of taking over the world. Both Toyota and Honda then started factories in the U.S. For Trump, it’s more about the deal than telling China what the country should do. China is a rival, but not necessarily the enemy.
Territorial Integrity
The Democrats have also ensured that the situation around Taiwan has escalated. For years, there was a status quo in which Taiwanese companies could do business in China. This was good for China and good for Taiwan. The fact that Beijing sees Taiwan as a renegade province and as an integral part of China is essentially correct.
The Chinese Communist Party was founded in 1921, partly through the efforts of the Dutchman Henk Sneevliet—who doesn’t know him? In the early 20th century, after the Opium Wars, China was largely in the hands of the British, French, Germans, Japanese, and Russians. There wasn’t much left of the Qing dynasty. The main goal of the communists was not even to establish an ideological utopia, but rather the pursuit of territorial integrity. Meanwhile, the former occupiers, long after the founding of the People’s Republic in 1949, continued to recognize only the Republic of China (Taiwan). The People’s Republic had to wait until January 1, 1979, for recognition.
2) Xi’s Reforms
Since the start of the reforms under Deng Xiaoping, China has undergone rapid economic development. Part of those reforms included adopting some policies from the era of the imperial dynasties. The country is simply too large to be governed centrally from Beijing. Hence the old Chinese saying: "In China, the mountains are high, and the emperor is far away."
More local freedom also meant more entrepreneurial spirit. In principle, every Chinese person is an entrepreneur, which is evident in other Asian countries as well. But with that freedom also came more corruption. Xi’s reforms were not only aimed at combating that corruption but also at strengthening Xi’s position, as he increasingly positioned himself as ‘the new great helmsman.’ The crackdown on local powerholders also meant tackling the large implicit monopolies like Alibaba, especially after Jack Ma openly criticized Politburo members in Shanghai.
The Free Market
Many of those reforms were aimed at improving the free market, not at a return to the communist utopia. Some regulations may have been somewhat paternalistic, such as the rule that young children should not play video games for too long. However, in this respect, Beijing never went further than the rules that companies outside China also had to adhere to.
For shareholders who own a monopoly or part of an oligopoly, such rules reduce their margins. But for the economy as a whole, it is ultimately positive, while the free market is more a characteristic of capitalism. Now the economy needs to be stimulated, and some of that regulation is being relaxed.
Demand Decline Cannot Be Solved by Stimulating Supply
The problem with the Chinese economy is that there is a decline in demand. Post-COVID, consumers are cautious, partly because a large portion of their savings is tied up in the faltering housing market. Beijing does not want to stimulate demand again because it fears Japanese-style conditions as a result of unchecked money growth. Instead, Beijing is mainly stimulating the supply side. No other country in the world has such a large trade surplus, and this also ensures that prices in China are falling. China still exports deflation. Eventually, Beijing cannot avoid stimulating domestic demand as well.
3) China’s Track Record
It is often said that one should not invest in China because there is no money to be made there. That would mean only investing in markets that have already risen significantly. If one were to apply that policy to other countries, one would not have invested in the United States in the 1930s or in Japan 15 years ago. The same sentiment that investors had then, they now have toward China. It’s a market that one can safely avoid. Incidentally, people thought the same about the United States right after the Great Financial Crisis. Things can change.
Peak of 2007
There have indeed been periods when the Chinese stock market outperformed other equity markets. For example, with the opening of the Chinese stock market to foreign investors between 2004 and 2007, there was a fourfold increase in prices, leading to a bubble peak in 2007 when Chinese stocks were trading at more than 30 times earnings. That was the moment to pull back. China single-handedly prevented a global depression in 2008. However, all that free money in China did compete with private initiative. In the years that followed, there was not much to gain for Chinese companies.
Chinese Tech Companies
With the rise of Chinese tech companies, the ‘animal spirits’ returned to the Chinese stock market. Chinese tech companies doubled in price between the 2020 peak and the 2021 peak: a spectacular outperformance. However, due to the strict COVID policy, the aforementioned reforms under Xi, and the deteriorating relationship with the U.S., Chinese stocks have since been under pressure. As a result, the valuation is now comparable to American stocks in the 1930s and Japanese stocks during the Tohoku earthquake. Those turned out to be unique entry points.
Conclusion
Now that the political situation seems to have hit rock bottom, there is a greater need to stimulate demand, and more liquidity in the form of a weaker dollar could give a boost to a country like China, China is a stock market with a low correlation with Western markets. From that perspective, it is also attractive to include Chinese stocks in your portfolio. Moreover, almost everyone has a negative view of Chinese stocks, almost as negative as everyone felt about including stocks in a portfolio at all in October 2022.
Given the large trade surplus, the renminbi is too cheap, and/or Chinese stocks are too cheap. The strong dollar has caused money to flow to the U.S. for years. A weakening dollar primarily benefits markets outside the U.S. Additionally, more and more people are worried about the valuation of the American stock market. Ironically, the higher-valued American stocks benefit from a weakening dollar because those companies generate a large part of their revenue outside the U.S. Moreover, the contrast with the low-valued Chinese stocks is significant. Too significant.