China has been in the news recently, both positively and negatively. This puts much nervousness amongst investors, so they are hesitant to put their money into China without some level of safety. However, in the long term, the continued economic growth of China may provide attractive investment opportunities. However, a high level of caution is needed when value investing in China.
China is one of the best markets in the world for value investors. It is possible to find great value as their market is still underdeveloped and not representative of their real economy. China’s financial services are expanding to international investors with the support of the Chinese government.
Basic characteristics of China
It should be no surprise that China and the US have a pretty big difference in approach to politics. But it may also be a surprise that they have many similarities. In 1949, China became a centralized planned economy with property owned by the state for the next 30 years. In 1979, influenced by Singapore’s wonderous development, China welcomed the free market economy and modern technology with the Shekou Industrial Zone of Shenzen and began to open up to the global economy. The economic outcome has been very similar to other nations that chose urbanization and globalization. China’s transformation has not been due to a change in the culture or the economy or system, but its civilization. The people of China have embraced science and technology into their nature.
The Chinese government’s regulatory goals are not so different from what the US and other developed countries have implemented. For example, China’s new regulations prevent business monopolies and encourage competition. There have also been extensive debates over data privacy and security over what Chinese companies can do with customer information. The government’s goal is to increase access to affordable health care, education, and housing. The difference is that China’s top-down approach allowed it to act unilaterally and much faster to implement these policies than the bottom-up approach used in the west.
Growth prospects of China
By being part of a global market, producers in China can take advantage of economies of scale, where the more customers there are, the more value is created. Modern science and technology will continue to produce more products at reduced prices to meet human demand and contribute to further economic growth. This process has little to do with politics and more to do with science, technology, and the free market. The chance that China will change this trajectory is minimal.
China has had incredible growth over the past 40 years. In 1990, China accounted for 1.3 percent of global GDP. In 2021, China’s share had risen to 18.6%. China has now surpassed the US to become the largest economy in purchasing-power-parity (using prices of specific goods to compare the absolute purchasing power of a country’s currency). It is also more than double India’s GDP. Also, in 20221, China’s net worth reached $120 trillion, overtaking the US’s $90 trillion.
Opportunities for value investing in China
Value investing will provide reliable, safer, and stable returns for investors. Chinese investors also have short-term trading and a high turnover mentality. This creates gaps in prices to a company’s intrinsic value creating more opportunities for long-term investors to take advantage of mispricing. If investors can take a long-term view and have the right mindset, they will have fewer competitors and a higher probability of success.
As China continues to open up to international investors and expand its economy, the increased role of the financial markets and the institutionalization of its businesses will continue to improve. Some investors may complain that the Chinese government is too heavy-handed regarding market intervention. However, from a long-term view, we should see China continue to improve and expand its financial markets, making them more conducive for investing in China. Value investors should be able to some great opportunities. If you stay the course for the next 15 years, you will likely become a great investor. The Chinese government has a significant stake in domestic companies. So the incentive for them is to let these enterprises continue to grow and let foreign investors help this growth by investing in China and its businesses.
Transparency and risk for investing in China
We have seen multiple Chinese government regulations that have significantly affected specific companies’ growth prospects. For example, online education from private companies has almost been made obsolete to alleviate the stress of additional school work on students. However, not all industries are being targeted. Drives that support the government’s agenda, such as the Made in China 2025 initiative that aims to reduce China’s reliance on foreign technology, have been able to avoid regulatory crackdowns. These sectors include renewable energy, high-tech manufacturing, autonomous driving, semiconductor manufacturing, and 5G technology.
Growing the Chinese middle class will be a constant theme in the government’s policies, but the government’s actions will determine how investors should allocate their capital. The top-down approach of the Chinese government has both negative and positive outcomes; on the one hand, they can move fast, and on the other, they can crack down on a whole industry overnight. It could be argued that regulation has not kept pace with China’s explosive growth, and that is why we are seeing a multitude of policies all come out at once. This makes investors very nervous.
For some, China’s economy is too large to ignore. The British consultancy Centre for Economics and Business Research estimates that China will overtake the US economy by 2030. China is on an excellent path to growth with a population of 1.4 billion, an ever-growing middle class, and a rapidly growing services sector. Several of its large companies are now global competitors trading at multiples much cheaper than their US equivalents. At these prices, the regulatory risk may be over-compensated. In the long-term, if regulation becomes more consistent and well understood, it could lower the risk of investing in China and provide opportunities for the long-term value investor.
