Investing in China, the risk and reward of Chinese stocks: Are Chinese Companies Worth the Risk?
The risk and reward of Chinese stocks is based on the individual performance of Chinese companies and the strength of the broader Chinese economy.
As a result of the outbreak of the coronavirus, originating in Wuhan China, economies across the globe have suffered. From huge dips in stocks and to economic shutdowns, businesses and economic growth have all suffered. China however appears to have got a handle on Covid-19 outbreak and looks set to continue into a V shaped recovery. This has largely been down to the booming tech sectors which has propped up markets globally.
The most recent publication of the China Rich List 2020 points to an ever growing fortune being made in China. Those in China with a wealth of 2 billion yuan or more have a combined wealth of 4 trillion dollars. This eye watering fortune surpasses the gross domestic product of Germany which is currently the world’s fourth largest economy. China’s economic strength appears to be continuing on an upward trend.
Long-term Economic Outlook
In the short-term China appears to be on the road to recovery from the economic impact of the covid-19 pandemic. Yet the longer-term future for the Chinese economy is even more impressive. PWC’s 2017 report ‘The World in 2050’ puts China well ahead as the global economic power. There is an expected shift in China from a manufacturing-based economy to a consumer driven economy. This shift could see Chinese companies expand even further, with faster growing tech companies benefitting the most. By 2050 China PWC estimates that China will hold the largest share of global GDP at some 20%.
Investing in China
With all that said, do these positive economic trends suggest that the risk and reward of Chinese stocks is weighed in favour of those investing in Chinese companies? To fully understand the value or otherwise of investing in Chinese companies it’s essential to look at the broader influences. Below I will outline both the bear (negative) and bull (positive) thesis for investing in China.
Bear Case
Trade Wars
The economic conflict between the US and China has been raging for several years now. Perhaps even longer than that if you delve further into the origins of the conflict. The Trade War between the US and China has inevitably had a negative impact on the stock of Chinese companies. The tit-for-tat imposition of duties and tariffs on imports from both countries has rattled investors. We have seen already how the mere threat of new tariffs can send markets tumbling. In fact, in May of this year (2020) Trump’s call for new tariffs sent Chinese stocks tumbling by double digits. There is no doubt that the Trade War has a bearish impact when measuring the risk and reward of Chinese stocks.
Delisting of Chinese Companies
The President of the United States of America has explicitly threatened to delist Chinese companies from the US stock exchanges. Furthermore, the presidential working group for financial markets has recommended the Trump administration seek delisting of Chinese companies on US stock exchanges. This recommendation was based on the current failure of Chinese companies to give US regulators access to their audits. Whether or not you believe these recommendations come from a desire to protect investors, the threat is real.
Fraud
The infamous case of Luckin Coffee and its eventual delisting from the Nasdaq has exposed the riskier side of investing in Chinese companies. In April of this year (2020) the COO of Luckin Coffee was exposed as having fabricated revenues to the tune of $310 million dollars. The extent of the fraud and the publicity it received is a stark reminder of the danger of investing in Chinese companies. What makes the likelihood of fraud in Chinese companies more likely than in US or UK companies is that they face little to no consequences. China has effectively given license to companies like Luckin to commit fraud as stock fraud against foreigners is not considered a crime. When considering the risk and reward of Chinese stocks the danger of becoming a victim of fraud is a valid reason to think twice before investing.
Bull Case
Economic Growth
China’s annual economic growth has surpassed that of any major economy in the world. This growth looks set to continue with China forecast to overtake the US as the world’s largest economy by 2050. As the leading emerging market, Chinese companies provide tremendous opportunities for investors seeking exponential growth over the coming years. Picking the right stocks to benefit from China’s economic growth could prove extremely lucrative for investors.
Shifting Economy
China is known as the “world’s factory” having focused on a manufacturing-based economy over the past decades. This focus on producing cheaply made goods for export across the world has enabled China to boast high single- and double-digit percentage growth. This looks set to change as China, much like the old European powers, has recognised that this current economic model is unstainable.
China’s economy going forward looks set to focus on a consumer driven services economy. The percentage of the economy which is based on services has risen from 40% in 2000 to 54% in 2019. As China’s middle class continues to grow and per capita GDP rises, consumer spending will ensure this trend continues. This consumer spending plays a huge role in the growth of Chinese companies and the stock markets. As we have seen during the Covid-19 pandemic, rising consumer spending online has poured rocket fuel on ecommerce stocks. A rising middle class in China will further boost all types of companies seeking to meet future consumer demand.
(Graph showing the growth of the service economy: courtesy of Investopedia)
Techological Innovation
China has already begun to establish itself as the glogal leader in technical innovation. It had once been the case that China was constanly playing catch up with the likes of the US, Japan and S. Korea in areas of technolgy. Now China is leading the way and boast some of the biggest technological comapnies in the world such as Alibaba and Tencent to name only two.
China’s 900 million internet users have embraced this technological revolution. Consumer spending online has helped China become a global leader in mobile payments. Online and mobile payments companies AliPay & WeChat had over 1.7 billion active users in 2019. Chin is focused on becoming the global leader in all high-tech industry. This includes mobile payments, AI, robotics etc and ensures this high growth sector has a bright future.
The risk and reward of Chinese stocks:
Final Thoughts
There is certainly a lot to digest when considering the risk and reward of Chinese stocks. There are number of reasons to be bullish on China’s economy and Chinese companies over the long-term. However, investing in China based companies does pose risks that we just don’t have when investing in US or UK stocks.
Despite this I am personally bullish on the Chinese economy and certain Chinese companies I believe are worth the extra risk. Should you decide to invest in Chinese stocks please ensure that you do your research and assess if this extra level of risk is right for your portfolio.
