Chinese stocks are cheap for a reason

China's stock market returns have been disappointing over the last few years. And they may be about to get worse.

China shows that rapid economic growth isn't necessarily matched by high stockmarket returns. The MSCI China index has only doubled since 2003, while the economy has grown more than fourfold. Although the last few years have been relatively disappointing for investors in China, the near future could well be worse, according to a recent research note from Deutsche Bank's John Paul Smith and Mehmet Beceren.

One issue facing the market is that overcapacity resulting from the lending spree of the past few years is set to crimp profitability. Part of the problem has been the central government's limited control of the regions: "the Chinese variant of Communism has always been much less centralised than itsSoviet counterpart". This has meant that reducing local loans or subsidies and enforcing industrial consolidation plans have proved difficult.

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