What force will shape the world in the next 20 years? The answer is China's drive to financialise, according to Diana Choyleva, founder and chief economist at Enodo Economics.

In this episode of the podcast, Diana speaks to MoneyWeek's Cris Sholto Heaton about how the AI race differs in China versus the West, the transformation of the country's equity market, and the breakdown of globalisation.

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Should you invest in China, or is it essentially “uninvestable”? That was the gist of the debate just a few years ago. The West can never quite seem to make its mind up about the Middle Kingdom. Once derided as cheap but tacky, in 2026 China is suddenly cool. Social-media influencers show off their indoor slippers and traditional Chinese medicine, while quipping that they are “learning to be Chinese”.

Polling by Pew Research shows that, while only 28% of Britons aged older than 50 have a favourable opinion of China, that figure doubles to 56% of the demographic aged 18-34. Where older Westerners see a repressive one-party state, the young scroll TikTok and share images of the futuristic “cyberpunk” city of Chongqing (it's worth a visit, if you can handle the brutal humidity).

A warning for those wanting to invest in China

This pendulum swing is nothing new. During the 2000s, China's extraordinary growth (14% in 2007 alone) led to feverish speculation about when exactly it would become the world's largest economy (2027, according to one widely cited projection). The story remained bullish during the early 2010s, as China used a massive infrastructure stimulus package to duck the stagnation plaguing developed economies after the great financial crisis. In the process, the country built the world's largest high-speed rail network, a service whose gleaming modernity makes Britain's trains feel like a donkey and cart by comparison.

But simultaneously, a more negative narrative took hold. The first signs of trouble came in summer 2015 after a parabolic run-up in Chinese shares went into reverse. The CSI 300 index plummeted 44% between June of that year and January 2016. A MoneyWeek cover at the time depicted a dragon roller-coaster hurtling downwards. In many countries, such a plunge would herald the beginning of a devastating recession. Not in China (GDP registered an official growth rate of 6.7% in 2016, a modest fall from the previous year).

In China, where the stock market is traditionally regarded as being little better than a casino, it is state banks, not investors, that decide where credit will be allocated. But it was a warning shot to investors. The most optimistic projections for Chinese growth didn't quite pan out. Today, total GDP is still only 65% of the US level, and a mere 15% of the level in terms of GDP per capita.

Still, grown it has, and at a rate and consistency with little precedent in world history. Yet those gains haven't accrued to those who decided to invest in China. Since the start of 2008, Chinese GDP has risen by 344%. The CSI 300? 1%. You can still make money if you invest in China, of course. Local shares have zoomed 43% higher since September 2023. But as a long-term investment, the case remains unproven. Stock markets rise and fall, but most trend upwards. It is the reason investing has a better reputation than gambling. Yet China's equity graph really does resemble a roller-coaster, with long climbs followed by hair-raising plummets.

China is far from the only emerging market to exhibit a disconnect between GDP growth and equity returns, although its case is especially extreme. The exact causes are much debated.

One important factor is simply that investors adore a good emerging-market growth story. That causes valuations to rocket, front-loading years of earnings growth into current valuations (something that current buyers of expensive Indian shares would do well to bear in mind).

A second reason is that many of the gains from growth tend to be captured off stock markets, particularly by landlords. Just imagine the fairy-tale returns from holding a patch of land in Shenzhen, an impoverished collection of fishing villages that blossomed in two decades into the centre of global technology manufacturing.

China's property bubble has burst

The gains to be had from property weren't lost on the Chinese. Newly wealthy Chinese households had few other investment options. Bank deposits pay miserable returns. Foreign shares are off limits, and the local stock market is volatile. So they went massively for bricks and mortar, buying second and third homes as investments. When built, these assets were often not even rented out, lest tenants detract from the much more important objective of maximising capital gains.

What followed was a property boom for the ages. During three years in the 2010s, China used more cement than America employed in the entire 20th century. The bubble was clearly getting out of hand. In 2020-2021, officials called time by imposing stricter caps on leverage. Property developers went to the wall, most famously including giant Evergrande, which imploded with $300 billion in liabilities. In 2023, Reuters estimated there were 7.2 million unsold homes. National property prices fell 40% between 2021 and 2025. That was devastating for a middle class that holds nearly 70% of its wealth in property. The property-shaped cloud over sentiment has yet to lift. In January and February, retail sales endured their weakest two-month start to any year since 2000 outside the Covid era.

There are plenty of other concerns for those looking to invest in China. The country's fertility rate is running at close to one child per woman, making it one of the world's most rapidly ageing societies. And a 2021 crackdown on tech firms (now largely reversed) was a reminder that all businesses ultimately operate at the pleasure of the Communist Party.

How China learnt from Japan's mistakes

Since the property bust, many economists have noted parallels between China and Japan. During the 1980s Japan was regarded as the world's most technologically advanced nation. Following the crash in the 1990s, its corporations slowly began to slip behind, failing to capitalise on the rise of the internet. But it looks as if China will avoid Japan's fate.

Tokyo spent the 1990s pouring money into zombie firms; in 2021, Beijing pulled credit from property and redirected it with military zeal towards the “New Productive Forces”, official jargon for things such as electric vehicles, rare earths, batteries, green technology and AI. Chinese companies are now conquering new global markets with terrifying efficiency. One in seven cars sold in the UK this year was Chinese, up from 1.3% just five years ago. Britain's top-selling car is currently the Jaecoo 7, a brand that almost nobody had heard of until recently.

China's critics have long pointed to what might euphemistically be called the country's relaxed attitude towards other nations' intellectual property. But China's days as a mere imitator of Western inventions are ending. As economics commentator Noah Smith notes on Substack, Chinese firms now know how to do things that Western companies simply can't replicate. Nowhere else has such a dense clustering of electronics and tooling engineers. Chinese firms are opening factories in other countries, and those factories are proving more productive than the foreign competition. Soon, the Germans will be copying the Chinese.

Better ideas are only one part of the equation. The other is lavish levels of state support, especially in the form of never-ending credit lines. Chinese factories are producing too much. The country's global export dominance – the trade surplus reached $1.2 trillion last year – is a symptom of the fact that there aren't enough domestic buyers to soak up a glut of batteries, solar panels and especially cars. China's manufacturers have turned to world markets not out of strength so much as desperation; razor-thin profit margins mean they are fighting to keep the lights on. China's industrial strength and its chronic deflation are thus two sides of the same industrial-policy coin. You might argue, as Smith does, that China is simply making a huge capital-incinerating mistake. But you might also argue, as Jeremy Warner does in The Telegraph, that given the choice between wasting capital on excess industrial capacity and wasting it on unsustainable welfare, as the West does, China is making the better strategic choice. Chinese industrial policy makes a lot more sense “if your objective is that of enfeebling the US... while insulating China against the sort of supply-chain vulnerabilities we see buffeting Western economies”.

Should you invest in China?

Will Chinese shares prove a good investment over the next ten to 20 years? Given the historical record of equity returns, the jury is still very much out. What does seem less likely today than even a few years ago is a repeat of the Russian experience, where foreign investments were effectively zeroed out following Vladimir Putin's invasion of Ukraine.

In 2022, the parallels with Chinese assets in the event of a Taiwan conflict seemed obvious. But the world has changed. It is far from clear that Donald Trump's America would stand in the way of a Chinese invasion across the Taiwan strait, and even harder to believe that the UK, acting in solidarity with the US, would cut off trade with China, the world's second-largest economy, as aggressively as we have sanctioned Russia, a comparative minnow.

Taking a one- to three-year view, the Middle Kingdom looks a reasonable bet. Firstly, because China's newfound coolness might just be a foretaste of a “vibe shift” about to occur in the market. Markets have always traded on narrative as much as cold, hard facts about Ebitda, and over the past decade, the rise of social media has only amplified this trend (how else can we explain car-maker Tesla's current price-to-earnings ratio of 324 times earnings?). Secondly, unlike Tesla's stock and its ilk, China has genuine value appeal. The MSCI China index trades on a very reasonable 11 times forward earnings, which should cap downside risks if anything goes wrong.

Punting the whole pension on Shanghai would be imprudent, but a trade that ticks both the momentum and value boxes deserves to be taken seriously. In 2026 the meme winds are blowing in favour of China. Given the entry price, it seems foolish not to lean into it.

The best ways to invest in China now

Before investing in China, it's worth auditing your current exposure. Enthusiastic buyers of emerging-market funds may well discover that they already have quite enough Chinese shares. As much as a quarter of many emerging-market trackers and funds are allocated to China. And for those nervous about conflict in the Taiwan strait, note that soaring semiconductor valuations have recently seen Taiwan's share of the emerging-market sector balloon, in some cases to another fifth or more of many funds.

By contrast, investors with a bias towards developed markets may be underweight China. China accounts for a mere 2.9% of the MSCI ACWI index (ranking behind the economic juggernaut that is Mark Carney's Canada). Compare that with China's 17% share of global GDP. There are sensible arguments for why Chinese markets shouldn't take up that much of a typical equity portfolio, but a 2.9% allocation is much too low for a country that is seizing the high ground in so many of the industries of the future.

The three leading active China trusts are Fidelity China Special Situations (LSE: FCSS), JPMorgan China Growth & Income (LSE: JCGI) and Baillie Gifford China Growth (LSE: BGCG). The funds have more similarities than differences, with each having put in a similar performance over the past 12 months, and a rising tech tide driving gains of about 25%. JPMorgan pays out a 4.7% dividend.

There is a solid case for active management in China, where Western investors will want to load up on tech and consumer shares, while steering clear of state-owned banks and low-quality firms. Fidelity has the best long-run record, but its slight tilt towards small and medium-sized firms may not be the best play at a time of relentless domestic deflation. Baillie Gifford, which has more of a growth bias, fits the bill better for those seeking a tactical momentum play.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Matthew Partridge: What prompted your book?

Ram Charan: I have been working in China for more than 20 years with American, European and Chinese companies; in some cases I was on boards as a director. The wake-up call was when I noticed that one US firm, which had a dominant position in the Chinese market, saw its market share begin to decline. Next, its unit costs went up and then the Chinese Communist Party basically forced them to sell their business to the Chinese.

This caused me to realise what China is trying to do – produce 90% of the global output in a sector, using a combination of subsidies, currency manipulation, and artificially cheap land and capital, and then using this to gain a cost advantage over the rest of the world. This strategy has already been applied to achieve a stranglehold over ten sectors in the past five years. This in turn creates a trade surplus, which is propelling China's military. It's a very sophisticated economic model, which essentially runs China as a conglomerate like General Electric.

The public may love it because it produces an endless supply of cheap goods. But in the longer run it means that non-Chinese companies cannot compete with China. And if war breaks out, this could become an existential issue.

MP: How likely is war between China and the US?

Ram Charan: We are already at war. The US House of Representatives Select Committee on China said it explicitly in October 2025: this is a war of mutual destruction; economic, technological, existential. The trigger will not be a single event. Cumulative economic strangulation will reach a breaking point. Xi has built something more powerful than an invasion: asymmetric chokehold capability. China can now shut down whole industries in America and Europe at will by controlling rare earths, battery components, semiconductor materials and advanced chemicals.

When Beijing announced requirements for export licences in October 2025, Donald Trump responded with 100% tariffs. The countdown has started. The real trigger is industrial collapse. When CEOs in the US realise they can't build anything without Chinese inputs, including defence systems, the political pressure for confrontation becomes unstoppable. Taiwan is the flashpoint everyone watches. But the invisible trigger is America losing the capacity to respond militarily because China controls the supply chains for defence manufacturing itself. China is stockpiling wheat, oil, commodities, and building the world's largest navy – 370 ships versus America's 290. It is expanding its nuclear arsenal to 1,000 warheads by 2030, and aligning with Russia and North Korea in a trilateral axis that can strike the US mainland in 30 minutes.

Xi Jinping is lighting proxy fires in Ukraine and the Middle East through local actors to stretch US military resources. Xi would prefer America to concede without firing a shot, but he is prepared to fight if the US does not yield. Unless America rebuilds industrial capacity fast enough to break China's chokehold, conflict is certain within the decade.

Matthew Partridge: What should the US do to combat the threat?

Ram Charan: Both the US public and firms must understand they are not competing with individual Chinese companies, but with the nation. And they can't compete alone. There must be more collaboration among both countries and firms. I have suggested that Trump create a Department of Manufacturing and Technology, whose full-time job is to co-ordinate, integrate and plan in a similar way to how the Pentagon organises the defence sector to fend off an equally powerful opponent.

Matthew Partridge: Didn't industrial policy fail when the UK tried it in the 1960s and 1970s? Witness British Leyland.

Ram Charan: British Leyland failed because bureaucrats picked products and ran factories. What I am advocating is government staying strategic, not operational. The Chips Act is an example. Government subsidises semiconductor making. Intel, TSMC, Samsung decide what to build and how to run operations. Government creates conditions for private companies to compete against state-subsidised Chinese opponents.

However, in addition to subsidies and support you will need enforcement of basic trade rules. Stop the dumping. Counter the currency manipulation that gives China a 20%, unbeatable pricing advantage. You also need to change US CEOs' psychology. They still think “cheaper currency, cheaper labour” is how you win. Move up the value chain. Import technology and equipment, not consumption goods. Scale up medium-sized manufacturers with AI and automation.

This is about national security. China has destroyed key US industries, including furniture, apparel, solar, rare-earth metals and ship components. The next targets are AI, biopharma, aerospace, advanced semiconductors, and chemicals. If those fall, America cannot defend itself. This is not industrial policy as socialism. This is industrial policy as survival.

Matthew Partridge: How can you ask other developed countries to work together under US leadership given that Trump has imposed high tariffs on them? Isn't that going to make them less likely to cooperate?

Ram Charan: I think people misunderstand Trump's approach. While it's true he has imposed tariffs, and this has created a lot of confusion, he has done this to rebalance trade between the US and the rest of the world, eliminating the large US trade deficit with most countries. Once this is achieved, his aim is to reduce these tariffs by as much as possible. Already small countries like Oman face barriers of as little as 2%. The idea is to bring countries to the table to discuss the issue, not protectionism for protectionism's sake. US tariffs will decline as the other sides reduce their barriers to US goods.

Matthew Partridge: You say that you are confident about the US because of the openness of its system and because of its big research infrastructure. But Trump has undermined this advantage with immigration controls and cuts to research budgets. Many of Trump's policies seem counterproductive.

Ram Charan: I agree that they are counterproductive. And that's honestly something I don't understand. Maybe it's due to his own ideological belief, but attacking universities is not consistent with his aim to reindustrialise the US.

Matthew Partridge: Moving from countries to companies, is it fair to say that investment in China is a double-edged sword? Many firms are being forced to give up their intellectual property (IP) in exchange for cheap labour and access to Chinese consumers.

Ram Charan: Yes, it is a double-edged sword. Not only will they steal your IP, but once a Chinese company shows signs of winning significant market share, Beijing will back it to the hilt, and give it a huge amount of resources to expand further, so it starts to drive you out of the market. The next thing, you notice you are making losses and decide to leave, or you get a call “inviting” you to sell up – as Starbucks and many others have done. Beijing's attitude, particularly in industries it has explicitly targeted, is that “until we get our own capability, you are our guest”– but once China starts to build its own domestic capacity, the Westerners are either asked to leave or driven out.

Some of the smarter companies started to work this out about ten years ago, and reconsidered their global strategy, including discreetly building up their operations in other countries, such as India. As a result, they are now doing very well, with their Chinese rivals still lagging behind due to the fact that they have not accumulated the necessary expertise that they would have gained from having a Western firm in their midst.

Matthew Partridge: What does India needs to do to become an attractive alternative to China for Western companies?

Ram Charan: In order to attract Western firms fleeing China, India needs to put its house in order. This includes smashing bureaucracy to make it easier for them to operate. India also needs to have better training in manufacturing, because manufacturing requires quality and reliability, and Indian firms have to learn to match customer specifications.

That said, India has some companies that are number one in the world. This includes Bajaj and TVS, which have done a great job of producing quality scooters, as well as other two-wheelers. So India needs to build on this to climb the value chain into products like semiconductors.

Matthew Partridge: Are there any other companies that stand to benefit from Western companies relocating from China?

Ram Charan: Every developed country will benefit from re-shoring to reduce dependence on China. Among developing countries, the other big winners will be Vietnam, Mexico and Indonesia. However, for companies, the solution is not substitution but diversification to break coercive power.

After all, Mexico and Vietnam are also proxies for Chinese production – Mexico's trade with China exploded after Trump's tariffs as Chinese companies set up Mexican operations to bypass US trade barriers. You must audit the entire supply chain. Where do the components come from? Who owns the factory? Where does the capital flow? Companies waiting for a single “China alternative” will wait forever.

Ram Charan has spent 30 years advising Fortune 500 CEOs on China. His latest book, China's 90% Model: China Has America by the Throat – Here's How to Fight Back and Win, is published by IdeaPress Publishing.

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Lunar New Year begins today (17 February), with the Year of the Horse celebrated in China and other nations that follow the lunar calendar.

According to Chinese astrology, the horse represents energy, ambition and endurance built through sustained effort.

Chinese equities had one of their strongest years since the Covid pandemic in 2025, and investors deciding where to invest for 2026 could consider investing in China for the coming year.

China’s stock market is celebrating its strongest lunar year since 2017: the Hang Seng Index gained 32% between 29 January 2025 and 16 February 2026, corresponding with the Year of the Snake.

The country’s economy is changing fast. A rapidly growing middle class is being bolstered by government policy encouraging consumption, while China is becoming a global leader in some of the world’s most transformative technologies.

“Policymakers in Beijing have become more explicit in emphasising the need to boost domestic consumption,” said Fiona Yang, manager of the Invesco Asia Dragon Trust (LON:IAD). “The 15th Five-Year Plan included the goal of meaningfully increasing household consumption as a share of gross domestic product (GDP) and positioning domestic demand as the primary engine of growth.”

While not accompanied by any major stimulus package, this emphasis on consumption could be constructive as far as China’s outlook is concerned, says Stuart Rumble, head of investment directing APAC at Fidelity International.

“The aim is to stabilise confidence and improve growth quality rather than drive a short term surge, implying selective upside rather than a broad based recovery,” said Rumble.

“Within that context, consumer sectors offer some of the lowest valuations in the market because expectations remain subdued, creating selective opportunity. In areas such as travel, sportswear and certain discretionary categories, domestic leaders continue to gain share and benefit from long term under-penetration trends.”

What do the experts think will be the key factors shaping China’s economy during the Year of the Horse – and which sectors do they think investors should target to profit?

Investing in China: A runaway horse?

The run-in to the Year of the Horse took place at something of an unruly gallop politically. Late in January, China’s top general Zhang Youxia was ousted as part of a purge that has seen the country’s Central Military Commission (CMC), which usually consists of seven members, reduced to just two, including president Xi Jinping.

“This marks one of the most dramatic ruptures in China’s political system in decades,” said Daniel Casali, chief investment strategist at Evelyn Partners. “The speed is unprecedented in the context of Chinese elite politics, where purged leaders typically vanish for months before any explanation is offered.”

The purge represents a fracturing of the balance between factions within the ruling Chinese Communist Party (CCP).

“Given China’s political opaqueness, with no clear line of succession to president Xi, this political uncertainty raises concerns over governance and could weigh on investor sentiment,” said Casali. “The risk for investors is that domestic political uncertainty could depress regional equity market valuations and returns.”

However, Casali added that Chinese and emerging market stock markets have so far shrugged off the political instability, and that both are primarily being driven by companies’ earnings growth within a supportive global economic backdrop.

China’s AI ecosystem

One of the key drivers behind China’s gains last year was the emergence of DeepSeek, an event which rocked Western stock markets and shaved nearly $600 billion off Nvidia’s market cap in a single session.

“The ‘DeepSeek moment’ acted as a pivotal catalyst for a broad revaluation of the country’s AI sector,” said Yang.

“The market has yet to fully appreciate how rapidly China’s domestic AI ecosystem is innovating around constraints, such as architecture choices, open-source diffusion, and engineering pragmatism that can compound quickly when capital is directed with intent and accompanied by policy support,” said Nicholas Yeo, head of China equities at Aberdeen Investments. “We would expect to see more of how companies are turning workarounds into products, which then get adopted and used widely through the ecosystem.”

The key question to ask before investing in China’s AI ecosystem is valuation, “especially after strong rallies in many ‘pure play’ names where profitability and durable earnings may still be several years away”, according to Rumble.

“Infrastructure providers and major platforms are monetising earlier, while many application focused companies are still in investment mode and, in some cases, valuations appear to anticipate cash flows that will take time to materialise,” Rumble added.

Yang picks out China’s tech giants Tencent (HK:0700) and Alibaba (HK:9988) as the biggest potential beneficiaries of China’s accelerating AI shift. “Their strong cloud infrastructure and rapid integration of advanced AI models have reinforced their roles as the foundational enablers of the country’s AI ecosystem,” said Yang.

China’s broader technological leadership

China’s status as the global leader in electric vehicles (EVs) was consolidated last year as domestic manufacturer BYD (HK:01211) overtook Tesla as the world’s largest producer of EVs.

“China is the world’s largest and most competitive [EV] market, with high penetration rates and domestic brands that have scaled rapidly on the back of deep supply chains and fast product iteration,” said Rumble.

It is likewise leading the way in robotics. “With a shrinking working age population, automation is both economic necessity and policy priority” for China, according to Rumble. Again, though, he cautioned that much future potential is already built into valuations of relatively early-stage companies in this space.

“The discipline lies in separating technological progress from sustainable earnings power and being mindful of how much investors are paying for access to these themes,” said Rumble.

How to invest in China during the Year of the Horse

Investors have an array of funds and investment trusts to choose from if they want to invest in China for the Year of the Horse.

Three investment trusts in particular focus on Chinese stocks: Baillie Gifford China Growth (LON:BGCG), Fidelity China Special Situations (LON:FCSS) and JPMorgan China Growth & Income (LON:JCGI). Of these, FCSS achieved the greatest share price return in the year to 16 February, gaining 30.9% compared to BGCG’s 22.1% and JCGI’s 22.7%, according to data from Morningstar via the Association of Investment Companies.

Note that other investment trusts like Invesco Asia Dragon provide exposure to China as well as other related markets.

According to FE fundinfo, the three funds focusing on China that delivered the greatest returns in the year to 16 February were the Invesco ChiNext 50 UCITS ETF (LON:CHNX) (gaining 61.1%), T. Rowe Price China Evolution Equity Fund (which gained 38.2%) and Allianz China A-Shares Equity Fund (which gained 35.0%).

In the late 1990s, a young Stella Li landed in Rotterdam from China with $30,000, a container load of lithium-ion batteries and an order from head office: “sell them to survive”. She clinched a deal with Nokia, then the number one mobile-phone maker. Never one for false modesty, she told the Financial Times: “I opened the door and moved BYD to another level.”

Nearly 30 years on, the company has moved far past its roots as a battery maker to become one of the world’s most powerful manufacturers of electric vehicles. Globe-trotting Li remains so firmly at the heart of its international expansion that colleagues have dubbed it “The Stella Show”. Yet the stakes, while much higher, are just as existential. BYD sales grew by 40% last year, but it is having to grapple with both rising Western protectionism and a darkening domestic outlook in China in the teeth of cut-throat competition. It’s going to be “very difficult for BYD to continue to grow the way it’s been growing”, says analyst Tu Le of Sino Auto Insights.

“A diminutive woman with almost frenetic energy,” Li, 55, “zips across the globe furiously, rarely making it back to her current home in Los Angeles”, says Fortune. In a typical day, BYD’s “crucial ambassador and strategist” might wake up in Istanbul, fly to a meeting in Vienna and then spend the night in Germany. The carmaker now exports to roughly 95 markets, but Europe is particularly crucial to its global push. In markets such as Britain – which this year became BYD’s biggest outside China – the company has become “Elon Musk’s worst nightmare”.

At its heart, BYD – which was founded in Shenzhen in 1995 by Wang Chuanfu – has always been a partnership. While Li led marketing and expansion, Wang, 59, was the engineer behind the group’s rapid technological advancements and manufacturing prowess. He never wavered from his dream of building electric cars, even when it looked like a long shot. The pair met soon after Li had graduated from Shanghai’s prestigious Fudan University and the relationship developed romantically as well as commercially.

BYD stands for “Build Your Dreams”, but back in the early days when Li was pestering mobile-phone executives in Atlanta suburbs with her box of battery samples, she used to joke that it stood for “Bring Your Dollars”, says Bloomberg Businessweek. Her great strength then was persistence. It took her two years to win a contract from Motorola. But by 2002, when BYD went public in Hong Kong and Shenzhen, the company was on a roll. Many investors were furious when Wang bought a majority stake in a failing state-owned carmaker a year later – appalled that BYD “was wading into a market it knew nothing about”. At the time, Wang didn’t even know how to drive, but was convinced that electric cars were “a natural extension” of the battery business.

The first clunky models did nothing to dissuade the critics, but Wang continued to pour cash into product development.

Stella Li's deal with Warren Buffett

The deal that put BYD on the map was Berkshire Hathaway’s landmark $232 million investment in 2008, says the FT. Li was introduced to Warren Buffett and Charlie Munger by her friend Li Lu, a billionaire hedge-fund manager. In the nearly two decades that Berkshire stuck with BYD until completing its exit this year, it reportedly netted a return of about $7 billion. In that time, BYD has achieved what Tesla, Ford and the rest of the car industry haven’t, says Businessweek: “build an affordable electric car for the masses and make money doing it”. Jean-Francois Baril, chair of Nokia’s owner HMD Global, who has known Li for more than two decades, credits her with “bridging the East and the West”, says the FT. She’ll need all that skill to keep BYD on the road in the years ahead.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

The trust is an actively-managed investment vehicle providing investors with broad access to China’s growth opportunities, from established technology leaders to entrepreneurial private businesses yet to list. Chinese equities have advanced strongly this year despite US-China trade tensions and a subdued property market. Low initial valuations and improving sentiment towards sectors driven by innovation (following DeepSeek’s breakthrough AI model) have also helped.

We focus on identifying companies with scalable growth potential, a sustainable competitive advantage and strong execution by managers. These often align with beneficiaries of long-term structural growth trends, such as China’s expanding domestic consumption and rapid technological innovation.

A particular emphasis is also placed on smaller, under-researched firms, offering attractive opportunities in mispriced stocks with healthy prospects. Here are three businesses the trust currently invests in.

China's growth opportunities

Hesai Group (Nasdaq: HSAI) is the world’s leading automotive LiDAR [light detection and ranging] provider, uniquely positioned at the heart of the fast-growing autonomous mobility revolution. As LiDAR becomes an essential component in advanced driver assistance systems (ADAS), Hesai’s ability to deliver superior technology at competitive prices sets it apart. As the market expands, Hesai is set to benefit from strong demand in increasingly sophisticated ADAS, which should help lead to substantial volume growth. While the vehicle industry will drive growth for many years ahead, there is also strong potential in other forms of mobility and robotics in the longer term. In addition, significant scope for margin expansion exists as volumes ramp up.

Xtep International (Hong Kong: 1368) has established itself as a leading Chinese sportswear brand specialising in the fast-growing running segment. Benefiting from the trend towards trading down in sportswear, Xtep is well positioned, combining affordability with a relevant brand.

Its sponsorship of marathon events and recognition for its shoes’ performance strengthen the brand’s credibility, while the strong growth of its premium Saucony brand broadens the product mix and supports the expansion of margins.

In the meantime, the company is trading at compelling valuations, while a solid dividend yield underpins attractive total shareholder returns. With strong branding and exposure to one of China’s most resilient consumer categories, I see Xtep as a structural winner in the domestic sportswear market.

Full Truck Alliance (NYSE: YMM) operates as China’s dominant digital freight-matching platform, leveraging powerful network effects to match shippers with truckers more efficiently than traditional offline brokers. Its scale creates a strong “moat” (an enduring competitive advantage), with network effects set to extend the group’s lead thanks to greater efficiencies and lower costs.

As penetration deepens and take rates (the percentage of a transaction for facilitating a sale) rise, Full Truck Alliance (FTA) is well positioned to deliver sustained growth in revenues from commissions, underscored by a record of resilient earnings with robust recent quarterly results. Having first invested in FTA as a private company, I’ve retained my long-standing conviction in its business model and strong execution. Since its public listing in June 2021, it’s remained a key portfolio holding, offering durable growth potential as China’s logistics industry continues its structural shift online.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

For a brief moment in January, Chinese tech start-up DeepSeek looked like it had re-written the global rulebook on artificial intelligence (AI) and the stock market.

The established narrative is that the US dominates technology. Lists of the most popular stocks for retail investors frequently include Magnificent Seven giants like Nvidia and Tesla.

But on 27 January, Nvidia’s market cap fell by almost $600 billion – its largest ever single-day decline – as Chinese AI start-up DeepSeek sent shockwaves through the global stock market.

Its flagship chatbot, DeepSeek-R1, could reportedly outperform most Western models, like ChatGPT, despite costing just $6 million to train (a fraction of the $100 million-plus that ChatGPT reportedly costs) and without relying on Nvidia’s most cutting-edge chips. That seemingly took the foundations out from Nvidia’s entire investment case.

Within a month, though, Nvidia’s stock had recovered most of the ground it initially lost, and while its share price declined towards April’s Liberation Day tariff announcement, it has since gone on to reach new heights, becoming the world’s first $4 trillion company in the process.

You could be forgiven for thinking that DeepSeek was just a flash in the pan given how quickly the US stock market has moved on from it.

But DeepSeek’s adoption in China has carried on apace, and the company could offer fresh tailwinds for the country’s much-maligned technology stocks.

What happened to the DeepSeek effect?

There were numerous reasons why the markets seemed to shrug off the initial explosive impact of DeepSeek’s arrival on the AI scene.

“People started questioning the viability and the reliability of the information that we had received over that weekend back in January,” says Bola Onifade, portfolio manager at JP Morgan-owned Nutmeg.

DeepSeek appears to have ‘distilled’ its model from OpenAI, the company behind ChatGPT. The process of distillation essentially replicates much of the performance of a large AI model in a smaller model, reducing its own costs, but not the total costs required to produce a model from scratch. In other words, Nvidia was still getting paid.

Reports also emerged that DeepSeek may not have been totally honest about its non-reliance on Nvidia chips. Officially, it wasn’t allowed access to the most advanced versions thanks to US export controls on strategically critical tech to China. The US commerce department started investigating claims that DeepSeek had managed to acquire controlled Nvidia chips before January was through; in February, Reuters reported that officials in Singapore had charged three men with fraud for allegedly procuring advanced Nvidia chips for DeepSeek.

It appears, even, that DeepSeek is heavily reliant on Nvidia’s technology. On 14 August, the FT reported that the launch of the company’s latest model, R2, had been delayed by DeepSeek’s attempt to train it using Huawei’s Ascend processor, China’s homegrown alternative to Nvidia’s chips.

The Jevons paradox: why DeepSeek boosted AI expectations

The main reason the market moved on from DeepSeek’s initial impact is that it realised that DeepSeek’s claims, even if true, were a bullish sign for the AI market, not a threat.

“There is definitely a positive angle for AI,” says Onifade. The faster, cheaper AI promised by DeepSeek enables faster adoption by companies further on in AI’s value chain, such as software companies or other industries.

“That’s a good story,” says Onifade. “There was a bit of scepticism, and then a bit of ‘actually, this might be good news for the entire AI complex.’”

This is a phenomenon that economists call the Jevons paradox, which contends that more efficient use (and therefore pricing) of a resource leads to greater consumption of it. Microsoft’s CEO Satya Nadella referred to it directly on X (formerly Twitter), stating that “As AI gets more efficient and accessible, we will see its use skyrocket, turning it into a commodity we just can't get enough of” while sharing a link to the paradox’s Wikipedia page.

DeepSeek’s impact in China

DeepSeek hasn’t directly made good on this promise in the US as of yet, largely because its usage has been limited over security concerns. That isn’t to say that plenty of Western companies aren’t busy learning about how AI can be built on the cheap.

But in China, it has been adopted at pace in both the public and the private sectors. Goldman Sachs predicted in February that AI adoption would start to boost Chinese productivity from next year, and deliver a 20- to 30-basis point boost to GDP by 2030.

“Big tech companies like Alibaba (NYSE:BABA) and Baidu (NASDAQ:BIDU), they’ve rolled out and integrated [DeepSeek],” says Onifade.

These companies, she says, are “in some ways farther along the integration journey".

“If you believe in the productivity gains that will be brought about by AI, I think you have to believe that companies that are at the forefront of adopting the technology will experience those gains, and deliver it in returns to investors," she adds.

All this is leading to rapid technological acceleration in the country.

“China tech is quickly ramping up its technology and not sitting on a treadmill,” said Dan Ives, head of global technology research at Wedbush Securities. “Tech stalwarts Huawei, Alibaba, Baidu, Tencent (HK:0700), Xiaomi (HK:1810) and others are aggressively looking to accelerate its AI technology ambitions.”

Should you invest in Chinese tech stocks?

Investing in Chinese tech stocks is in many respects akin to entering a completely different ecosystem from that to which Western investors have grown accustomed.

China is the only world region where Amazon, Microsoft and Google are not the top three cloud vendors. In China, those spots go to Alibaba, Tencent and China Telecom (HK:0728), with Huawei taking fourth spot, according to data from Synergy Research Group.

One of the advantages of buying Chinese tech companies is that they are relatively undervalued compared to their US counterparts.

While Magnificent Seven stocks mostly trade at multiples of 30 times projected earnings or higher, Alibaba currently has a forward P/E ratio of 14.2, and Baidu’s is just 12.

However, the rationale for this undervaluation is that investing in Chinese stocks carries risks.

“You’re dealing with a very heavyweight government,” says Onidafe. That has its advantages – for example, the massive amount of resource the Chinese government is putting behind initiatives like ‘Eastern Data and Western Computing’, which seeks to build a huge data centre network in the west of the country.

But it can, and has, played out badly for Chinese tech stocks. The ‘tech crackdown’ that followed the government’s blocking of Ant Group’s IPO in 2020 is a poignant case in point.

“Investors have sticky memories – they recall these events,” says Onifade.

But at the current moment, she adds, the government is supportive of its tech industry. “This is a positive time to look at China again and think about what portfolio allocation should be over the coming years, with the embrace of some of the tech names in China.”

How to invest in Chinese tech stocks

Buying into China’s tech ecosystem is not as straightforward as investing in US big tech, as China is slightly more closed to international investors. Some Chinese tech companies, like Baidu and Alibaba, have American Depository Shares (ADS) listed on US stock exchanges like the NASDAQ – these can be bought and sold in the same way as US tech stocks, though you will need to check exchange rates when assessing companies’ fundamentals.

Others, such as Tencent and Xiaomi, are available as Pink OTC stocks which are often viewed as riskier, given the lower regulatory requirements for companies to list. Alternatively, if your provider allows you to, you may be able to buy these companies’ Hong Kong-listed shares.

An easier route to invest in Chinese tech stocks could be to invest in funds that offer exposure. At a basic level, this could be via an index fund like MSCI China, which as of 31 July has an 8.4% weighting towards the IT sector – not including companies like Tencent or Alibaba, its two top constituents which account for a combined 27% of the index and are classified as consumer services and consumer discretionary, respectively.

Investors seeking a more targeted approach could select a fund like Fidelity International’s China Innovation Fund, which targets Chinese tech companies offering growth and quality at reasonable valuations. Top ten holdings as of 31 July include Tencent, Alibaba and Xiaomi.

Whatever else happens this year, Robin Zeng can claim one pivotal moment. In May, he took the contrarian bet of pushing ahead with a secondary listing of CATL in Hong Kong. It proved transformative, says the Financial Times. Shares in the company, a pioneer in batteries for electric vehicles (EVs), surged, lifting its market value to roughly $166 billion in the world’s biggest IPO of the year.

The float jump-started the wider market out of its post-Liberation Day slump, with the Hang Seng index now up 30% in the year to date. Leading the rally in confidence, amid new optimism about a trade détente between the two superpowers, is China’s battery king – now a Hong Kong citizen and vying with business magnate Li Ka-shing for the title of Hong Kong’s richest person, with a net worth of some $40 billion.

Not that he apparently cares, says The Wall Street Journal. Zeng might have built CATL into a global juggernaut – its batteries were installed in one in three EVs globally last year – but he represents a new kind of tycoon flourishing in Xi Jinping’s China: understated, philanthropic and ready to echo official state talking points. “I don’t want to be the rich guy,” he observed on the eve of the float. “I want to share these riches to create a good society.”

Zeng, 57, emerged during a turbulent period for tech executives and has learned the lessons – leveraging his know-how “and the state’s willingness to throw money at the renewable energy and EV industries” while keeping his head down. He toes the line on Xi’s vision for China, “where ostentatious displays of wealth aren’t tolerated and humility is the sentiment of the day”. His draws inspiration from the early Chinese sage Confucius, with his “lifelong learning and continuous moral improvement”.

How Robin Zeng made his money

Born in 1968 as Zeng Yuqun, he grew up in poverty in a mountain village in the southeastern province of Fujian – near Ningde, where CATL is now based. “A strong student with big ambitions”, Zeng won a place at the prestigious Shanghai Jiaotong University. He quit his first job at a state-owned enterprise in Fujian after just three months and moved to Dongguan to join an electronics manufacturer, studying part-time for a PhD in physics at the Chinese Academy of Sciences. In 1999, he started his own company, Amperex Technology (ATL), producing lithium-ion batteries. Apple was an early customer. Zeng realised his first fortune in 2005, when he sold ATL to Japan’s TDK for $100 million, says The Wall Street Journal. But he “stuck around”, setting up a car-battery division. TDK was banned from the Chinese market because it was a foreign company, so Zeng started CATL in 2011.

“The timing was perfect” – Beijing had begun prioritising EVs and was offering generous subsidies. As with ATL, Zeng built the firm’s reputation on a contract with a blue-chip Western brand, BMW. A big boost came in 2015 when Beijing told global automakers they would only qualify for subsidies if they used batteries from approved Chinese suppliers, including CATL. Within a year, revenues rose from $1.2 billion to $9 billion.

Zeng sees himself as much more than a battery-maker, says the FT. His ambition for CATL is to become “the pioneer” of the broader zero-carbon economy. He’s particularly interested in lowering the energy costs of vertical farming, telling Bloomberg that “if you solve agriculture, then you’ve solved everything”. Yet CATL remains at the mercy of politics. In January, the US added the firm to a blacklist of companies with alleged links to the Chinese military (a claim denied by CATL). That threat might have receded, but it hasn’t gone away. Moreover, entrepreneurs like Zeng are at the whim of Xi, says Desmond Shum, the Hong Kong businessman who wrote Red Roulette. “If you don’t understand this, you’ll be the first one slaughtered.”

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After two days of marathon talks in London, the US and China have agreed to “roll back” some of the “punitive measures” they had taken and restore the trade truce agreed in May, says Alan Rappeport in The New York Times. The meetings followed a reportedly friendly call between Donald Trump and Xi Jinping last week. Negotiators, led by US Treasury secretary Scott Bessent and Chinese vice-premier He Lifeng, are expected to seek final approval for the “framework agreement” from both leaders; assuming they approve, it will take immediate effect.

Although the two countries reached a 90-day tariff truce in Geneva on 12 May, “deep and fundamental differences remain” – including disputes over “currency manipulation, export subsidies and other non-tariff barriers”, says Linggong Kong in The Conversation. The Geneva deal came under pressure after Washington accused Beijing of “dragging its feet” on an agreement to speed up the export of rare-earths, while Beijing accused the US of being the first to break the agreement by rolling out a wave of fresh measures, including new restrictions on the sale of AI chips and chip-design software to Chinese companies, and cancelling visas for Chinese students. The day after the agreement, Trump also issued an order banning US firms from using Huawei AI chips.

A win-win for both US and China

From China’s perspective, it returned to trade talks with a “strong hand”, says Katrina Northrop in The Washington Post. Its “geopolitical ace card” is its control over much-needed rare-earths, which are critical components in products as varied as cars, fighter jets, iPhones and medical machines. China accounts for 70% of global rare-earth mining and more than 90% of the processing. Yet “for all its bravado”, Beijing doesn’t actually “hold all the cards”.

Economic growth remains weak; it was grappling with a property crisis even before any trade frictions, and exports to the US have declined by a “precipitous 34%” (although this has been offset by increased sales to Europe and Southeast Asia).

China is vulnerable to controls on high-tech exports from the US, particularly cutting-edge semiconductors, which it has not been able to produce domestically, hindering its ambitions to become an AI leader. The US also supplies China with more than 99% of a key export, ethane, and could apply pressure by “stepping up sales of arms to Taiwan”, says Bloomberg.

Nonetheless, the truce is good news, says Matthew Lynn in The Spectator. The “most important single trading relationship in the global economy is starting to get back on track”. But time is short. Trump has only “suspended the tariffs until August” so a “broader agreement” will need to be reached by then. China will almost certainly have to make some “big concessions”, including allowing the US tech giants (Meta, Netflix, et al.) full access to its domestic market, and boosting domestic consumption in order to reduce its trade surplus with the US. In return, Trump could lower tariffs permanently, allowing China to maintain the “export-led growth model that has transformed its economy over the last 30 years” and keep expanding into tech-based industries traditionally dominated by the West. Such a deal “won’t necessarily happen”. However, if it did, it would be a “win-win for both sides” and provide a “huge boost” to the global economy.

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There’s no question that Chinese stocks have been a huge disappointment for investors. Over the past decade, the MSCI China index – the standard benchmark for foreign investors – has delivered a gross total return of 3.9% per year in sterling terms, barely half the already-disappointing return for the MSCI Emerging Markets ex China.

It used to be easy enough to argue that the overall market was poor because of the large number of state-controlled firms with little concern for their minority shareholders, but there were still excellent opportunities in technology or consumer goods. Yet that has been a harder case to make lately, since many of the big private-sector names have been weak over the past five years.

Still, taken at face value the market now looks cheap: the MSCI China trades on ten times forecast earnings. Certainly that reflects the presence of many poor-quality companies, but a valuation this low redeems a lot of sins for investors willing to take the risks.

Two problems that floored Chinese stocks

And there is no shortage of risks. We can come up with a list of reasons to worry about China in the medium term. There’s demographics: the population is set to age faster than almost any other country. There’s geopolitics – its territorial interests may one day bring it into direct conflict with other powers such as the US, particularly its insistence that Beijing should one day rule Taiwan, regardless of the views of the Taiwanese people. These are real concerns for investors over the next decade.

That said, we can find reasons to be bearish about almost any country and these have little to do with how poorly the economy and the stockmarket have performed over the past few years. Instead, we can put the immediate problems down to two things.

The first is the bursting of the real-estate bubble. Property had become a huge proportion of GDP – about 25% including both direct and indirect demand – and a key source of growth. It had also become wildly over-supplied, over-valued and over-indebted. The biggest problem with the decision to bring it to an end by curbing lending to developers is that the tougher rules came far too late. Policymakers made the same mistake as Western governments in the 2000s of letting a real-estate bubble run for far too long, with the result that tackling the problem became even more painful.

The second is the crushing of “animal spirits” in the economy, through a series of other crackdowns on tech firms, finance and some smaller sectors. As with real estate, there were often solid arguments for the government to intervene. The giant tech firms had taken advantage of limited regulation and state influence (compared to many sectors of the economy) to build dominant positions and to try to extend this as widely as possible. There was a risk of ending up with entrenched monopolies that harmed consumers and smaller businesses.

The problem was that the crackdowns showed all the traits that worry investors most about China: very sudden changes to regulations, no certainty on where the limits would be, a lack of fundamental private property rights and rule of law, and unambiguous signs that private-sector firms would be squeezed in favour of state-owned enterprises, and increasingly co-opted into serving the priorities of the government rather than shareholders.

China's government must do more

No wonder that foreign investors became relentless sellers and talk of China being “uninvestable” was common. The sluggish performance of the A share markets – stocks listed in Shanghai and Shenzhen – showed that domestic investors were becoming increasingly pessimistic as well.

However, last year there were some signs that the government has pivoted and is becoming more pro-growth and even a bit more pro-business. There have been some moves to boost consumption, support the real-estate sector and provide more financing for local governments. This led to a pop in Chinese shares in September, but the gains have not been sustained. Investors feel the government hasn’t done enough to turn around the economy and that it needs to do more, especially in real estate. The widespread consensus is that the property sector is so influential there is no way to get growth going again without stabilising it in the short term. There is also a fair amount of optimism that the government will do more. If it does, China is so unloved there is a lot of potential for markets to rally.

There are three trusts in the China specialist sector. While they share many major holdings, they also feel distinctively different, which is helpful for investors. All trade on similar discounts of 10%-11% at present, so the decision is really down to strategy.

The largest by far is Fidelity China Special Situations (LSE: FCSS) at £1.6 billion in assets, which last year merged with Abrdn China. One would not call this a value fund, but relative to the others it has a tilt to value and to mid-cap and small-cap stocks. It has the best return of the three over most recent periods, despite carrying the most gearing (23% now) in a tough market.

Next, at £225 million, there’s JPMorgan China Growth and Income (LSE: JCGI). This targets an annual dividend of 4% NAV, paid quarterly, but it doesn’t specifically invest for income – the portfolio has a growth tilt. So some of the payout will come from capital, as is increasingly common with higher-yielding trusts.

Lastly, Baillie Gifford China Growth (LSE: BGCG), with £160 million, is focused on growth stocks in sectors such as tech. This is the former Witan Pacific trust, which was turned over to Baillie Gifford with a new single-country focus in October 2020. The timing of this was not ideal given the crackdowns, and it has fallen a long way since (although better than JCGI). However, if the outlook is genuinely changing, its approach could be a beneficiary.

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The new moon on 29 January marks the start of the Chinese lunar new year. This time it’s the Year of the Snake, which follows the Year of the Dragon.

Investors looking for the top funds and stocks will be hoping for a repeat of last year: the main index of Chinese stocks, the CSI 300, gained 18.3%, after a 9.1% fall in 2023.

However, while there will be plenty to celebrate in terms of the Chinese New Year festivities plus last year’s stock market performance, the arrival of the snake looks set to usher in an uncertain year, full of challenges, which could take a venomous bite out of investors’ returns.

Top of the list is the prospect of tariffs following Donald Trump’s re-election. Trump has said he is considering imposing a 10% tariff on imports of Chinese-made goods as soon as 1 February.

In traditional Chinese culture, the Year of the Snake embodies qualities of introspection, intelligence and adaptability. And the country will arguably need to channel all of these, to adapt to whatever this year brings, whether it’s dealing with Trump and recovering from its property crisis to winning the AI race with DeepSeek.

We asked investment managers what they thought of China’s prospects this year.

Has China resolved its past problems?

Abbas Barkhordar, manager of the Schroder AsiaPacific Fund, says: “Consumer confidence remains very depressed due to a weak property market and uncertain prospects for consumer income. Externally, certain industries have faced greater restrictions on trade and investment. This has led GDP growth to slow, inflation to fall to near zero and the outlook for company earnings to deteriorate.

“Many of the structural concerns facing the market – demographics, excess housing inventory, stricter regulation, barriers to trade – remain, but there is some hope that the government’s announcement of co-ordinated monetary and fiscal stimulus in September last year will lead to an improvement in growth and confidence in 2025. The undemanding valuations of the Chinese and Hong Kong markets suggest there is scope for a positive surprise should policy improve.”

Ian Hargreaves, co-manager of Invesco Asia Trust, comments: “The scale of last year’s surprise stimulus package and its endorsement by senior officials not only sparked an immediate rebound in Chinese equities, but crucially suggests renewed determination from officials to support the economy and stabilise asset prices. Restoring market confidence is back on policymakers’ agenda, which could help improve fundamentals.

“Whilst this is positive, we will not know how effective these stimulus measures will be until after they are implemented. Policy announcements so far have been focused on lifting financial pressure off over-indebted local governments, but this has fallen short of market expectations. We expect further stimulus measures, but history tells us authorities are likely to tread carefully, being wary of encouraging speculation, leverage and unnecessary financial risks.”

Will McIntosh Whyte, multi-asset fund manager at Rathbones Asset Management, says the property crisis casts a long shadow over the Chinese economy. He explains: “After years of frenzied homebuilding and rampant speculation by businesses, local governments and households, billions of dollars are now locked up in property that isn’t worth what it cost to buy. The lucky ones have the keys to empty apartments; the unlucky have had to swallow the loss of big deposits while looking at half-finished shells that will likely never be completed. Estimates suggest up to 60% of China household savings have been funnelled into property, and so the property malaise has a clear impact on consumer confidence.”

He adds: “More recently the economic data coming out of China has been more positive. This includes a bounce in exports, but one must be wary this could potentially be front loading ahead of tariffs. Equally the very low inflationary environment the country faces – at times flirting with deflation - hardly feels indicative of a healthy economy.”

Will China slither to success in the Year of the Snake?

Rebecca Jiang, portfolio manager of JPMorgan China Growth & Income, comments: “We remain optimistic about the outlook for the Chinese market. Firstly, valuations are still attractive. Although they recovered in September and October 2024, they are still at relatively low levels compared to market history. For example, the price to book of the index is still below its level during the global financial crisis in 2009.

“Secondly, corporate reforms focused on improving capital allocation and shareholder returns are likely to have a positive impact on the market. Many cash generative companies are now more willing to distribute cash to shareholders either through dividends or share buybacks. Developments in this direction have been greatly welcomed by domestic and international investors, as they view dividends to be a more predictable source of return. Whilst many cash-rich businesses are already increasing payout ratios and undertaking share buybacks, there is still considerable scope for many to do even more, which should have a further beneficial impact on valuations over time.”

Qian Zhang, investment specialist at Baillie Gifford China Growth, says: “Our on-the-ground research is painting a clear picture: Chinese companies are becoming increasingly competitive at a global scale. They are transforming from producers of cheap, low-quality goods to leaders in a number of globally critical industries. We can point to many examples in the portfolio from white goods producer Midea, to battery giant CATL, to the world’s largest electric vehicle maker BYD.

“Despite a weak domestic consumption environment, companies like Pinduoduo (e-commerce) are quickly gaining market share as consumers increasingly look for ‘value for money’ options. Western semiconductor restrictions have also forced a new collaboration mechanism among Chinese semiconductor companies and some domestic leaders are starting to emerge.”

However, Bola Onifade, portfolio manager at digital wealth manager Nutmeg, says that while valuations are attractive to bargain hunters, especially after a rebound in performance last year, “challenges in the world’s second largest economy present a ‘valuation trap’ to investors”.

She warns: “China remains in a tough spot as it attempts to shift its economy from an investment-led model that has seen the efficiency of capital invested fall over the decades to a consumption-led economy. Despite impressive GDP growth, this shift has proven to be slow and painful with consumer confidence and household borrowing remaining low. Consumer wealth is also concentrated largely in real estate, in contrast to the US, exacerbating recent challenges in the property sector.

“Beyond these structural challenges, investors also need to consider the potential risks posed to China’s growth by the new administration in the United States. Reports suggest that the president is considering imposing new tariffs on Chinese-made goods, potentially harming existing supply chains and exporters.”

Will McIntosh Whyte, multi-asset fund manager at Rathbones Asset Management, adds: “The recent AI breakthrough from DeepSeek reminds us that China remains a highly innovative and economic powerhouse. Tariff fears remain an overhang, and it appears China is keeping some stimulus packages in reserve until there is more clarity. But tackling the property overhang is no quick fix, and this likely remains a drag on the economy for some time.

"Having said that, Chinese equity valuations arguably factor a lot of these concerns into their valuations, and any form of positive news, be it more stimulus or a pick-up in consumer sentiment, could see a significant rally for an unloved asset class.”

What are the biggest risks to your investment outlook?

Ian Hargreaves, co-manager of Invesco Asia Trust, comments: “Tariffs are a concern, but Donald Trump is known to be transactional, and the tariff agenda is about US reindustrialisation – to incentivise foreign companies, including Chinese companies, to move production to America. If markets feel there is a floor under US-China relations with Donald Trump in the White House, then that could be supportive of sentiment.

“Geopolitical risks are hard to analyse and price effectively, but we are alert to what the market appears to be pricing in, as well as the potential for other governments to respond with stimulus of their own, and for corporates to take measures such as cutting costs and diverting business away from the US to other markets. For example, China could further boost its economy, targeting specific sectors, to try and offset any negative impact from tariffs. We prefer looking at the potential impact of the US election on a case-by-case basis, and so far, have not made any changes to the portfolio.”

Abbas Barkhordar, manager of Schroder AsiaPacific Fund, notes: “Although there are potential headwinds from higher tariffs and US interest rates, it should be remembered that the first Trump presidency coincided with strongly positive returns for Asian stocks, as higher US growth benefitted the region’s exporters, despite more restrictive trade policies.

"There is clearly still a great deal of uncertainty about what the actual policies of the Trump administration will be in his second term, and the impact that these will have on Asia, which is of course a risk to the investment outlook. However, any policy changes are likely to also create some winners across the region, not just losers.”

How much should you allocate to China?

With China still regarded as an emerging market, it is riskier for investors than more established countries, and financial advisers generally recommend only limited exposure to China within a balanced portfolio.

Tom Stevenson, investment director at Fidelity, tells MoneyWeek that “a maximum of 5% of your money in China would be a rough yardstick”. This could be via an emerging market investment fund, an Asia fund, or perhaps through a global equity fund.

For example, Fidelity Asian Smaller Companies has about 30% of its assets in China, while Stewart Investors Asia Pacific Leaders has 9% allocated to the country. “If you would like more limited exposure to China, a global fund is one option. For example, the Dodge & Cox Worldwide Global Stock fund has 3.9% of its money in Chinese stocks,” says Stevenson.

He is dubious that the Year of the Snake will be auspicious for the Eastern giant. “Things have arguably got a whole lot more difficult for Asia and emerging markets since the US presidential election. Tariffs, a strong dollar and higher US bond yields are not a recipe for outperformance. Earnings growth is likely to be lower and valuations will be under pressure too.

“In the key regional market, the Chinese authorities are expected to respond with increased stimulus. It was hopes for this that triggered the dramatic rally in share prices in September 2024, but subsequent market volatility has reflected doubts about the pace and scale of support.”

Chinese shares rose 15% in 2024 for their first annual gain since 2020, says Bloomberg News. But “sentiment remains fragile”, with the CSI 300 index enduring its worst first trading day of a new year since 2016. Most of last year’s equity gains came following a “late September stimulus blitz”. Yet since then trading has been “range-bound” as investors wait for official announcements of more economic stimulus.

Why are Chinese stocks tumbling?

Stock markets have been cheered by a $1.4 trillion package of support for indebted local governments and promises of easier monetary policy, but bonds are telling “a bleaker story”, says Jacky Wong in The Wall Street Journal. Local bond yields have been falling – suggesting investors anticipate low inflation and weaker growth.

China’s 30-year bond yield traded at more than 4% in 2018, but recently fell below 2%, less than the equivalent in deflation-prone Japan. Japan learnt the hard way that “it takes strong, overwhelming stimulus to exit a deflationary spiral”. Markets aren’t convinced help on that scale is in the pipeline in China.

State stimulus certainly moves markets in the short term, says Nicholas Spiro in the South China Morning Post. This autumn’s announcements saw the CSI 300 rocket 32.5% between September 23 and October 8. Yet despite continued measures aimed at stabilising the property market and helping consumption, trading has turned “volatile” in recent months. “The size... of the stimulus package” may be “less consequential than previously assumed”.

Economists are also concerned about deeper “structural challenges, including heavily indebted local governments, an ageing population” and “excessive dependence on exports” says Reshma Kapadia in Barron’s. But stimulus is part of the picture and we may be in line for more – especially if Beijing is pressed into extra spending this year to offset Trump’s planned “volley of increased tariffs on Chinese imports”.

The bulls haven’t been routed. Goldman Sachs notes that government spending “has historically had a stronger impact on Chinese equity returns than monetary easing”, says Cao Li in the South China Morning Post. Goldman argues the stimulus policy puts a “floor” on the Chinese equity market. Moreover, says Hudson Lockett for Breakingviews, firms are “undervalued” and boast “higher cash flow and profitability relative to global peers”.

Yet sentiment is “precarious”. Tech giant Tencent’s shares sold off 7% in Hong Kong on 7 December after it was added to a US list of “Chinese military companies”. The classification carries “no material consequences” but shows that “perception” is important, too. Fund managers who bought into “last year’s rally” may start to conclude that “buying into the bull case is more trouble than it’s worth”.

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The trust aims to provide investors with access to a wide range of opportunities in China, leveraging the unique advantages of its structure, such as the ability to use gearing, invest in private companies, and employ derivatives. I look for firms with scalable growth potential, strong returns on capital based on a clear competitive advantage and strong management.

These often align with secular growth trends, but I pay close attention to cyclicality, as it can also present opportunities. I prioritise management teams with a proven record of strong execution and favour under-researched small- and mid-cap stocks capable of outperforming the market.

Where to invest in China

One company I have invested in is Medlive Technology (Hong Kong: 2192). It operates a leading online platform connecting pharmaceutical and medical device companies with doctors, providing medical information, clinical guidelines, and diagnostic tools.

Its core strength lies in digital healthcare marketing, and it is benefiting from the ongoing shift of healthcare budgets from offline to online channels. Medlive has demonstrated robust growth, with its client base and the number of products promoted rising significantly.

Despite recent anti-corruption crackdowns, the long-term outlook for drug and medical device development in China remains strong, driven by a shift from sales and promotion to increased investment in research and development.

As more new drugs are developed, pharmaceutical companies will require enhanced marketing support. Medlive, with its focus on precision digital marketing, is well-placed to benefit from this transition. With limited competition and ample reinvestment opportunities, Medlive remains a compelling long-term growth story.

Ping An Insurance (Hong Kong: 2318) is one of China’s leading financial services providers, offering a wide range of insurance and investment products. China’s insurance sector remains underpenetrated compared with Western markets, presenting strong long-term growth potential.

Ping An is well positioned to capitalise on this, benefiting from robust demand in life insurance, particularly in elder care and critical illness coverage. It is gaining efficiency through investment in technology and bolstering risk control through better asset-liability management, tighter underwriting standards and improving the sales force’s skills. Meanwhile, the stock is attractively valued at a discount to book value, with strong capital return policies delivering an appealing dividend yield.

Tuhu Car (Hong Kong: 9690) is China’s leading car services provider, leveraging digitalisation to transform customers’ experiences, standardise services, and drive efficiency. The company’s platform integrates booking, parts ordering, service tracking, and technical support, creating a highly scalable, capital-light model.

In a fragmented market dominated by small local players, Tuhu has consolidated its position as the largest player, with over 4,000 franchised stores. China’s ageing car fleet is fuelling demand for maintenance, and Tuhu’s scale – it is one of the world’s largest purchasers of tyres – gives it significant pricing power.

The group also has substantial scope for expanding its margins through private-label products, increasing offline traffic, and enhancing high-value chassis services. The trust first invested in Tuhu as a private company, so I’ve known it for a long time. With few direct rivals and a proven growth strategy, it still stands out as an attractive long-term investment.

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China has exhibited remarkable growth over the past 45 years, transforming it into a land of superlatives. It is the world’s biggest exporter, its second-largest economy and, over the past few decades, it has undergone the fastest process of urbanisation in human history.

“No one has really been looking at China for the past few years, but actually there’s a lot of interesting things going on,” says Sharukh Malik, portfolio manager, Asian & Emerging Markets at Guinness Global Investors.

Since the late 1970s, China’s GDP growth has averaged over 9% a year, according to the World Bank, and almost 800 million people have lifted themselves out of extreme poverty. This has helped transform China into a nearly $19 trillion economy, second only to the US in terms of GDP.

When you look back at this recent history, investing in the country could sound like a no-brainer. But the post-Covid era has been difficult for anyone investing in China. The MSCI China index fell 22% in 2021, 22% in 2022, and 11% in 2023 as Covid lockdowns and a regulatory crackdown on its technology sector weighed heavily on Chinese stock valuations.

China’s economy also continues to grapple with an ongoing real estate crisis as well as continuing US-China trade friction.

But there are signs that prospects are picking up for investors in China. Chinese stocks reversed their run of three years of declines in 2024, gaining 20% through the year, and the index has returned nearly 40% so far in 2025.

^{Source: MSCI}

This year’s rise has coincided with Chinese technology stocks coming into the forefront, particularly after the emergence of artificial intelligence (AI) start-up DeepSeek.

“Confidence has been building thanks to improving economic growth, targeted government stimulus, and ongoing strength in innovation-led sectors like electric vehicles (EVs) and AI,” said Kate Marshall, lead investment analyst at Hargreaves Lansdown.

So what’s the state of play with Chinese stocks – and should you invest?

The challenges and opportunities of investing in China

The investment landscape in China is changing. Wind the clock back to 2023 and sentiment was dominated by three (very negative) themes: the property market, geopolitical tension and a domestic regulatory crackdown.

“Some investors walked away,” Linda Lin, head of the China equities team at Baillie Gifford, told the Association of Investment Companies showcase on 10 October.

But on the ground, the shoots of positive change were there: government officials had already started to vocally advocate the interests of private companies, according to Lin.

“Private companies are not the side story; they are the economy,” said Lin. “They are contributing 60% of GDP, 70% of technological innovation, and 80% of urban jobs.”

Xi has previously been accused of prioritising ideology over growth, but this stance has shifted in recent months. “Over the last year we have seen Beijing take a more pragmatic turn,” said Lin. “It is now not about tolerating the [economic] headwinds, but about leaning against them.”

Besides the real estate boom and bust, another obvious cause for investor concern is the threat of tariffs from the US. While these tensions appear to be thawing, investors are often cautious about investing in China due to the prospect of trade barriers with the world’s (other) largest market.

But despite its size, the US only accounts for around 14% of Chinese exports, and these US exports in total account for less than 3% of China’s GDP. So even a major disruption of the trading status between the two countries wouldn’t necessarily throw China’s economy completely off-course.

China is the top trading partner for more than 140 countries worldwide, and has overtaken the US on this metric.

“America’s share of world GDP is falling,” says Malik. “The emerging world is becoming a bigger part of the pie, and that’s where China’s future is.”

China’s shift up the value chain

Perhaps the most significant structural opportunity within China is its emerging position as the world leader in high end technology products – which both Lin and Malik characterise as a move up the value chain.

It is particularly evident in the country’s growing dominance in advanced technologies, such as electric vehicles (EVs) and solar panels.

China manufactures 70% of global EVs and 75% of the global battery market, according to the IEA, and in 2024 built more industrial robots than the rest of the world combined.

Lin said this is driven by three layers: a top-down industrial policy with a focus on strategic areas like AI and semiconductors; a bottom-up layer of innovation driven by Chinese entrepreneurs; and the scale of the Chinese market, which Lin said “helps product innovation and increases adoption much faster than people think”.

“The [Chinese] government is playing a huge part in rolling out data centres so more businesses have it open to their operations,” says Malik.

Malik envisages that the additional growth from these new pillar industries will outweigh the drag from real estate, and that this inflection point will occur either in 2026 or 2027. That could lead to “10 or 20 years of solid growth” in China, he says. And industrials – hugely overlooked at present – ought to be able to ride this wave, without exposing portfolios to the risky valuations at which Chinese AI sometimes carry.

How to invest in China

You are probably under-exposed to China in your investments. Most of the world is: the country accounts for 18% of global GDP, but just 3% of the MSCI All World Index – less than Apple, as Lin points out.

Buying Chinese stocks directly can be complex and will depend on your broker. In general, American depositary shares (ADS) or receipts (ADR) are easier for UK-based retail investors to access, but some brokers will offer access to Hong Kong-listed shares.

Some stocks that could offer exposure to the technology growth trends in China are robotics company Midea (HK:0300), battery producer CATL (HK:3750) or BYD (HK:1211), which this year overtook Tesla as the world’s largest seller of EVs.

Malik favours investing in industrials, a part of the market that has “mostly been ignored by investors because they’re just chasing AI”.

In his view, a risk-averse investing approach can be advisable when looking at Chinese stocks. “In China, the competition is just so intense,” he says. “Something that did very well last year, a million companies could flood into the sector and wipe away the advantage.”

He added: “It’s risky in China to make big bets on bad companies becoming good companies… Our broad style is to find companies which have already done okay in the past, have already got a good track record, and look for opportunities where that excellence is being undervalued by the market.”

Funds and investment trusts can be another way to gain access to Chinese stocks, including mainland-listed companies that can be harder for individual investors to access otherwise.

Guinness’s Greater China Fund and China A Share Fund both follow an equal-weighting strategy, meaning they rebalance their portfolios to ensure that all holdings have a roughly equal allocation within the fund. “When something becomes too big, you lock in the gains and bring it back to neutral,” says Malik.

Baillie Gifford’s China Growth Trust (LON:BGCG), meanwhile, has a stronger focus on buying growth stocks and letting these run. Top holdings as of 30 September are Tencent (HK:0700) at 13.4% of the portfolio, TikTok owner ByteDance at 8.8%, Alibaba (HK:9988) at 7.7% and CATL at 3.6%.

Alternatively, investors could select a pan-Asian fund that offers some geographical diversification.

Schroder Asian Alpha Plus offers China exposure as well as some diversification across Asia. “Investors looking for exposure to China without the volatility of a single country fund could consider a broader Asian fund,” says Marshall. “The Schroder Asian Alpha Plus fund invests in countries across Asia. Over half the fund currently invests in China, Taiwan and Hong Kong. It also invests in other emerging markets such as India and Vietnam.”

The world’s capitalists are feeling cheerful, says John Authers on Bloomberg. Why? Because the “politburo of the world’s largest communist state” is warming to the idea of more welfare spending. There are “enough ironies… to sink the Titanic”. Chinese stocks leapt 8.5% on 30 September for their best day since 2008. Over five sessions the CSI 300 index has risen an astounding 24%. In Europe, luxury shares, which are highly exposed to Chinese consumption, also rallied strongly.

Why are Chinese stocks rising?

The excitement came after a statement by the politburo suggesting Beijing is open to using fiscal stimulus to “prod consumers to start buying stuff again”, something economists have been advising for years to little effect. Stronger social support policies are also on the table. There are as yet “no numbers”, but the declaration of intent from political leaders has been enough to trigger a surge of confidence in stock markets.

“Gone is the equivocation on deleveraging, moral hazard and provincial indebtedness, a staple of previous politburo meetings,” says Marko Papic of BCA Research. “This is Beijing’s ‘Whatever It Takes’ moment,” he says, a reference to Mario Draghi’s famous declaration in 2012 during the euro crisis. Investors are dreaming of a repeat of China’s “massive” 2008 stimulus, which helped the country avoid the worst of the global downturn, says James Mackintosh in The Wall Street Journal. But that splurge also left the economy with many of its current problems, including local government debt, overcapacity and excess housing.

China’s central bank had earlier unveiled a series of measures designed to tackle the housing slump, including easier monetary policy and cuts to mortgage rates for existing housing, says Anthony Anastasi for the South China Morning Post. But making credit cheaper doesn’t address the country’s fundamental “structural imbalance” – consumption is too low, while investment and savings are too high. High investment was a good strategy when China needed to build out its infrastructure and factories, but now all those factories are pumping out products that local households don’t have the cash to buy. What’s needed is a rebalancing towards consumption.

That is why the politburo’s hint of big fiscal stimulus to come has excited markets, says Reshma Kapadia in Barron’s. With the official 5% growth target “in jeopardy”, officials seem to have become “alarmed enough to shift out of slow gear”. For markets, the big question now is whether political statements are followed up with significant cash.

Some foreign investors are cautious, says the Financial Times. “We have seen these fits and starts, where China puts in place some kind of stimulus, and it has not resulted in a long-term constructive recovery,” says Saira Malik of asset manager Nuveen. “We’d be looking for more follow-through in terms of a pick-up in economic activity.” Others caution that a more immediate threat to the rally is coming into view: a possible Trump victory in the US presidential election and the prospect of a renewed US-China tariff war.

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• China’s reopening has delivered a timely boost to Asia’s economies and financial markets
• Asian exposure needs to weather near-term risks, while also focusing on long-term secular trends
• Dividend investing in Asia does not necessarily come at the expense of growth

China’s reopening has reversed a significant period of weakness for Chinese stock markets and renewed enthusiasm for the Asian region more widely. Amid this environment of greater confidence, is an income strategy the right way to harness opportunities in Asia?

As economic activity resumes with China’s reopening, there are multiple beneficiaries: from the pandemic laggards, such as travel and leisure companies, to consumption related industries, which are benefiting from reviving consumer confidence. The positive effects have spilled over to the export-oriented markets of Taiwan and South Korea, while tourists are also beginning to return to popular destinations such as Thailand.

This underlines China’s pivotal role in Asia’s economic recovery, and its reopening bodes well for the region’s prospects in 2023. In addition, inflationary pressures are not as acute in Asia as in the West. This gives Asian companies a notable advantage and resilience over their Western peers, which are facing rising costs and labour difficulties.

While the operating environment appears to be changing for the better in Asia, investors would also need to consider potential near-term risks. Recovery within China is unlikely to be a straight line, albeit we expect domestic consumption to underpin economic growth this year as the country reaches herd immunity fast. The real estate market is stabilising, and we are monitoring domestic sentiment which, in turn, depends on buyers’ confidence in an economic recovery.

Broader inflation and interest rate concerns are still very real. Persistent inflation and a strong labour market are giving the US Federal Reserve pause for thought when it comes to moderating or ending its cycle of interest rate increases. The global economy remains fragile with recession risks in Europe and the US, while geopolitical tensions could also act as a break on Chinese growth.

More recently, banking turmoil in the US and Europe has caused jitters across markets because of concerns that this could result in tightening funding conditions and potential regulatory squeeze, which in turn, could hurt asset quality, the growth recovery and capital flows in the Asia Pacific. The question is what next and this is why we have always backed the banks that are well-capitalised, well-funded, have conservative underwriting and treasury management, and have not taken unnecessary risks to grow. Our bank holdings may even benefit from a flight to quality for both deposits and maybe even wealth management flows in the case of the Singapore banks.

Against this backdrop, we believe it is vital to position Asian exposure to weather near-term risks, and we believe that a portfolio of quality holdings with sustainable competitive advantages and robust balance sheets, which are less reliant on debt financing and continue to display financial strength, will protect their margins and dividends better even in the face of persistent inflation and a higher rate environment.

Over the longer term, investors should also focus on the long-term secular trends playing out across Asia, such as huge consumer markets, technology and green energy. The region also has favourable population demographics. These themes are creating opportunities in areas such as digitalisation, healthcare and wealth management.

Income and growth

Unlike in some Western markets, dividend investing in Asia does not necessarily come at the expense of growth. Many Asian companies pay stable dividends while also growing at a decent pace. Equally, income investors are not confined to low growth sectors. For example, the Abrdn Asian Income Fund has a high weighting in information technology stocks, focusing on areas such as hardware, semiconductors and foundry companies. The trust holds companies with strong balance sheets that are also growing their revenues and dividend payouts over time.

In Asia, dividend contribution has been on a steady upward path, helped by greater capital discipline and shareholder-friendly reforms. It now comprises close to half of total returns to shareholders. 2022 was a bumper year for dividends globally, but particularly so in Asia. The MSCI AC Asia Pacific ex Japan Index had a dividend payout ratio of 45% and a gross aggregate dividend yield of 3.4% as of end-December 2022, trumping most other major global markets on both metrics. On the trust, we increased the dividend by 7.5%, a 14th year-on-year increase, giving investors a significant head-start in outpacing inflation.

Valuations remain reasonable across Asian markets, while earnings have been at cyclical lows and look set to recover. There is still abundant choice of businesses that generate good profitability and cash flow and pay higher than the benchmark dividend. At the same time, their strong balance sheets should provide some defensiveness if the reopening trade proves bumpier than expected.

Portfolio in action

This balance of leaning into the recovery while managing potential risks is in evidence throughout the portfolio. The trust holds an overweight to Singapore, for example, because it provides a quality screen in accessing growth in markets such as Malaysia, Indonesia, Thailand and even China. The big banks in Singapore, such as OCBC, have exposure to China’s burgeoning small and medium-sized enterprises (SME) sector. The consumer-oriented and tech-linked names that we hold are hitched to secular themes, including e-commerce and technological development.

Our tech hardware and semiconductor holdings in TSMC and Samsung are the two largest positions for the trust. The dividend yield for both looks quite low, but these companies have grown their dividends per share on a dollar basis and follow a dividend pay-out policy that is linked to their free cash flow generation. Looking ahead, earnings growth for these market leaders looks well supported as prospects for high-power computing, data centres and servers remain compelling, while AI complexity would boost semiconductor demand and overall market expansion.

‘Going green’ is a strong theme across the portfolio, with significant government support for the renewable energy transition across Asia. Among the trust’s holdings here, electric vehicle (EV) battery manufacturer LG Chem has a cash generative chemicals business that provides funding for new investments and R&D in the energy storage space. LG Chem is now one of the top five EV battery players globally. PowerGrid – the national grid of India – is spending at least 20% of its capital expenditure on renewable energy sources, while also paying a compelling yield.

The opportunities from the reopening of China – and its impact across Asia – can be harnessed effectively through a dividend strategy, which may also provide greater protection against some of the risks. There is growth opportunity in income strategies in Asia and dividends have proved extremely resilient through the economic turbulence of recent years. Investors could be missing out if they focus only on growth strategies to participate in the region’s recovery.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein, and not as an investment recommendation or indication of performance.

Important information

Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.

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Issued by abrdn Capital International Limited, registered in Jersey (38918) at 1st Floor, Sir Walter Raleigh House, 48-50 Esplanade, St Helier, Jersey JE2 3QB. abrdn Capital International Limited is regulated by the Jersey Financial Services Commission under the Financial Services (Jersey) Law 1998 (as amended) for the conduct of investment business and fund services business. abrdn Asia Limited, registered in the Republic of Singapore, Registration Number 199105448E.

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1

CLSA, Factset, 31 December 2022

2

Bloomberg, 8 March 2023

It’s no secret global investor’s view of China has grown darker as the world’s second largest economy emerges from its strict zero-covid policy. You may be wondering if now is a good time to invest in China. 

Anyone holding funds and stocks in the region will have noticed a lacklustre economic recovery since Beijing loosened its stringent pandemic era restrictions and re-opened its economy last December, prompting investors to look for alternatives. 

However, Matthews Asia investment strategist Andy Rothman argued that the general consensus view on China may be too negative.

The analyst believes that investors are underestimating the resilience of local consumers and entrepreneurs, as well as the pragmatism of policymakers.

Rothman said most of the developed world moved on from Covid-19 two years ago, while the last wave of Covid-19 cases and deaths in China only ended in January 2023, restraining household sentiment and spending. With each passing month, Rothman thinks that Chinese consumers should regain more confidence, supported by high savings and strong income growth.

“The resilience of Chinese consumers and entrepreneurs, as well as the pragmatism of the country’s policymakers, have often been underestimated, and that is likely the case again today,” he said to justify his “glass half full” view on China.

Beijing’s policy course correction in pursuit of the ‘common prosperity’ agenda “is more likely to improve corporate and consumer confidence than any traditional stimulus because it is designed to address concerns that Xi is no longer supportive of entrepreneurs”, Rothman added. 

“This is, of course, just talk, but I believe that Xi’s priority is restoring economic growth. I expect him to follow up with concrete actions.”

Still, even Rothman laid out some of the obstacles ahead.

What are the risks associated with China’s economy? 

Although China is expected to see a post pandemic growth just as other countries have seen, Elizabeth Kwik, co-manager of abrdn China argued that there are still some risks investors should keep in mind.

“Further escalation of US-China tensions, particularly over Taiwan, remains a lingering issue but we do not at this point expect any sudden surprises considering the tone adopted by both countries following last November’s meeting between Presidents Xi Jinping and Joe Biden.”

Although China is sending less of its goods to the US, it has gained market share elsewhere. China’s share of global exports in the first quarter of 2023 was 14%, compared with 12.8% in 2017, before the Trump tariffs.

Other headwinds to the economy include China’s debt, there’s an overhang on China’s property crisis, unemployment and ageing population.

Rothman said that cleaning up China’s debt problem will be expensive, and does limit the government’s options for fiscal stimulus, but will not likely lead to a dramatic hard landing or banking crisis.

“China’s debt problem is serious, but the risk of a hard landing or banking crisis is, in my view, low,” he said.

Should you invest in China now?

For bargain hunters and long-term investors, China could be worth a look with experts saying the country is most likely set for growth.

Rebecca Jiang, co-manager of JPMorgan China Growth & Income, said: “We remain optimistic about the long-term prospects for the Chinese economy, which continues to be bolstered by the strong entrepreneurial ethos of China’s private businesses as well as the growing demand from the country’s burgeoning middle class.”

A number of experts say they expect this year of the rabbit to be one of recovery and an accelerated activity as the zero-covid policy is rolled back - and this indeed good be an excellent time to get into China.

Sophie Earnshaw, co-manager of Baillie Gifford China Growth, commented: “China is likely to be one of the very few major economies where growth could accelerate in 2023, enjoying a reopening recovery like much of the rest of the world had in 2022. In the longer term, we continue to think the policy focus on quality of growth instead of quantity of growth will provide exciting stock-picking opportunities in areas such as green transition, hard technology, consumption upgrade and industrial automation.”

Exposure to China: Funds and trusts to consider

If you’re looking to add exposure to China to your portfolio, these are some funds and trusts to look at according to interactive investor’s Dzmitry Lipski, head of fund research.

Fidelity China Special Situations Trust - provides broad, diversified exposure to Chinese equities, including 'H' shares listed in Hong Kong and mainland-listed 'A' shares.

Fidelity Asia - this will give you exposure to a broader range of emerging markets or Asia

Guinness Asian Equity Income Fund - this will also give you exposure to a broader range of emerging markets or Asia

JP Morgan Emerging Markets Investment Trust - holds just over a fifth of its portfolio in China. Tencent is the portfolio’s third biggest holding.

Scottish Mortgage Trust - it’s worth knowing its long-running theme has been its holdings in Chinese internet stocks, such as Tencent and Alibaba. According to interactive investor, it has a 10% allocation to China, which would be good news for the trust after its returns in Scottish Mortgage Trust have seen a 40% slump in recent months.

After significant weakness earlier in 2022, both onshore and offshore Chinese equity markets have recently bounced back strongly.

In the period from the end of April to July 22, the Shanghai A-share Index outperformed the S&P 500 Index by 11% and the MSCI Emerging Markets Index by 15%. This rebound came after Chinese equities had underperformed for much of the previous year, following the Common Prosperity drive, which began in summer 2021.

The important question for investors now is: Can this improvement be sustained?

Drivers of earlier weakness

A challenging economic backdrop has weighed on Chinese equities since late 2021. The latest consensus expectation is that China’s economic growth will halve to 4.2% in 2022 from 8.4% in 2021.

(1)

This slowdown reflects the country’s ongoing real estate downturn and its zero-Covid policy, which has resulted in economically damaging lockdowns in major commercial centres including Shanghai and Shenzhen. China equity investors have also had to contend with unhelpful regulatory conditions, both home and abroad.

Easing headwinds

Moderation of some key headwinds has driven the the recent rally in China equities. On the Covid front, China’s zero-tolerance approach has been effective in reducing the number of new cases very significantly. The seven-day average of daily new cases was less than 1,000 as of July 24 — a small fraction of earlier this year, in mid-April, when there was a high of nearly 30,000 cases. This has enabled some controls to be relaxed, including less stringent quarantine rules. This has given way to an uptick in Chinese economic activity lately (Chart 1).

Chart 1: Recovering China economic activity

Source: Research Institute, abrdn, July 2022

On the regulatory side, there have also been clear signs of the new regime bedding down, allowing some easing of pressures. For example, in June, the government gave tentative approval for Ant Group, an affiliate of e-commerce giant Alibaba, to revive its initial public offering in Shanghai and Hong Kong.

Comparatively helpful policy backdrop

Another contributor to improved performance lately has been China’s comparatively much more helpful monetary and fiscal backdrop. Unlike virtually all other major central banks, the People’s Bank of China has not felt the need to join the global trend of sharply raising policy interest rates. On the contrary, since the start of 2022, it has eased policy on multiple occasions through a combination of interest-rate and reserve-requirement cuts. China has been able to adopt this markedly different monetary stance because, compared to the rest of the world, it's experienced very low inflation, which was running at just 2.5% year-over-year in June.

On the fiscal front too, policy in China is more supportive compared to the rest of the world. For example, our economists think infrastructure spending especially could get a significant boost from efforts to bring forward local government bond issuance.

Valuations not prohibitive for further outperformance

Despite the recent rally, the valuation of China equities remains more attractive compared to many global equity markets. For example, the MSCI China Index forward price-earnings (PE) ratio of 11.1 suggests significant cheapness compared to the MSCI US Index and MSCI All Countries World Index, which have forward PE ratios of 16.3 and 14.2, respectively.

(2)

Despite the recent rally, the valuation of China equities remains more attractive compared to many global equity markets.

At the same time, the forward earnings projections for China corporates seem more than adequate. For 2023, consensus estimates are for 7% revenue growth and 4.7% net margin, which would produce 15% earnings-per-share growth, relative to the expected lower base of 2022.

(3)

Risk factors

However, optimism regarding the outlook for China equities should be qualified by respect for some weighty risk factors. First, while restrictions have been incrementally easing in the past two months, the dynamic zero-Covid policy has not been discarded. This means that new restrictions are still possible, although we think that future lockdowns are likely to be much more targeted and adaptive.

Second, the important property sector, which by some estimates, together with related services, accounts for around 25-30% of China’s GDP, remains a headwind. Until further deleveraging is completed, the sector will probably remain vulnerable to adverse news flow. Recently for example, concerns have been rising that mortgage defaults could rise owing to a wave of homeowners joining a nationwide mortgage payment boycott for unfinished homes. However, given potential contagion risk, we expect the authorities to be very proactive in addressing this issue.

Putting everything together

Putting everything together, we think there are enough reasons to be relatively optimistic regarding the outlook for Chinese equities. In particular, the combination of these factors suggests scope for continued outperformance:

• Easing Covid restrictions
• easing regulatory pressures
• Accommodative monetary and fiscal policy
• Relatively undemanding valuations

However, investors would be wise to temper their optimism with due appreciation of the risks, especially regarding the dynamic Covid policy and unresolved stresses in the key real estate sector.

Overall, we think the present environment underscores the need for a selective investing approach that favours Chinese companies with attractive fundamentals, low exposure to the macro risk factors and undemanding valuations.

1 Consensus Economics, 11 July 2022

2 Global Index Briefing: MSCI Forward P/Es, Yardeni Research Inc., 19 July 2022

3 China Equity Strategy - Bullish 2H22 outlook on macro & micro, J.P.Morgan, 22 June 2022

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“For a market deemed on the verge of ‘uninvestable’ a few months ago”, China looks “pretty perky”, says Craig Mellow in Barron’s. The CSI 300 index lost 23% between 1 January and a low in April, but has since rallied 11%.

Without abandoning “zero-Covid”, officials have signalled a shift to a more “dynamic” approach that makes greater use of targeted testing and largely eschews draconian lockdowns of the type seen in Shanghai this spring. Stimulus is incoming, with the central bank easing lending conditions and another infrastructure splurge on the way. Crucially for investors, “regulatory assaults on internet companies have eased” – witness Alibaba’s 40% share-price gain since mid-March.

“Stringent Covid lockdowns” saw China’s economy contract by 2.6% between April and June, say Li Wei, Ding Shuang and Hunter Chan of Standard Chartered. Yet more recent data “points to a continued economic recovery”, with industrial production up 3.9% in the year to June, while the retail sector expanded by an annual 3.1%.

“We expect China’s economy to improve further in the run-up to the 20th Party Congress [this autumn] on increased stimulus and less disruptive Covid-control policies.”

The economy is not in the clear yet, says Ian Williams in The Spectator. A sagging property market “now threatens to spill over” into “a local banking crisis”, as shown by recent scandals at “provincial banks”. The sector is “heavily indebted” and “weighed down with bad loans”. That compounds fears over local-government debt worth an estimated 44% of GDP lurking in the opaque financial system.

The Nasdaq Golden Dragon China index, which tracks US-listed Chinese firms, lost 67% between February 2021 and June 2022, says David Brenchley in The Times. Is this a buying opportunity? Chinese shares have become “regarded as a pariah asset the same way energy was in 2020”, says Mike Coop of Morningstar Investment Management. Like energy shares, they could soon enjoy a renaissance. The MSCI China index trades on an undeniably cheap cyclically adjusted price/earnings (CAPE) ratio of 11.9.

Yet money managers now prefer to gain exposure to China via nearby regional markets or Western firms with operations in the country rather than by buying local stocks directly, says Sofia Horta e Costa on Bloomberg. “Even if you have a positive macro view on China, [it’s] hard... to sell Chinese stocks,” says Jamie Dannhauser of investment firm Ruffer.

Some European pension funds reportedly “no longer want China in their portfolios because of rising geopolitical and governance risks”. As Ruffer’s Matt Smith puts it, “the supertanker of Western capital is starting to turn away from China”.

Chinese e-commerce giant Alibaba Group Holdings has been hit by “what appears to be one of the biggest data breaches in history”, says Cissy Zhou in Nikkei Asia. Its shares fell by 6% last Friday after executives were called in by the Shanghai police to be questioned about the affair.

The problem began a fortnight ago when a hacker offered to sell online records from the Shanghai police database. He said he had “information about one billion Chinese citizens” and posted a sample of 750,000 records. The Chinese authorities are furious that the data, which reportedly contains “names, ID numbers, phone numbers, addresses, criminal records and even online orders” appears to have been stolen from a server hosted by Alibaba.

The leak is particularly embarrassing for Alibaba given that founder Jack Ma “was an early evangelist of the use of data in policing and social control”, says Karen Hao in the Wall Street Journal. Indeed, Ma’s claims that Big Data “would help the public security agencies track down thieves and predict terrorist attacks” has helped Alibaba become “the biggest public cloud-service provider in China”.

But this relationship has not always been smooth. The ministry in charge of technology suspended a cybersecurity partnership with Alibaba’s cloud-computing unit last December after Beijing alleged the company “failed to report a global software vulnerability to it in a timely manner.”

Was it the government’s fault?

Still, it looks like Alibaba is being made a “scapegoat” for the Chinese government’s failings, especially its “astonishing lack of cybersecurity caution despite its own user data protection mandate”, says Yawen Chen on Breakingviews.

It seems that in this case the government left the data “sitting around without a password”, which means that “anyone could have accessed [it] if they knew the web address”. However, even if Alibaba wasn’t at fault, this may not matter, as the scandal could dent other clients’ confidence, “especially those from the public sector”.

Alibaba isn’t the only firm worried about the fallout, say Sarah Zheng and Coco Liu on Bloomberg. This episode may only “fuel Beijing’s resolve to clamp down on domestic tech giants and accelerate a move away from their private cloud services”. Such a migration is already under way, with the ongoing crackdown on “formerly high-flying tech giants” nudging risk-averse institutions toward state-owned providers.

Technology firms are now also likely to be affected by a new Chinese competition law, says Lex in the Financial Times. The law, which comes into force in August and requires Chinese companies with global sales of $1.8bn to receive government approval before merging, doesn’t target the technology sector specifically, but it will have an “outsized impact” on the industry. Before the pandemic and the clampdown, Alibaba and Tencent “accounted for nearly half of all venture-capital flow for acquisitions in mainland China”.

“China has shifted from driving global growth to driving global volatility,” OECD chief economist Laurence Boone tells Les Echos. The intergovernmental think tank thinks the country will grow by just 4.4% this year. “China is still suffering from the difficulty of moving from an economy centred on its exports to an economy more dependent on internal consumption.”

Investors in China have more immediate concerns. Listed tech firms have lost about $2trn in value over the past 12 months as regulators tighten the screws. Repeated Covid-19 lockdowns and growing geopolitical tensions have also darkened the mood. But now “some of the darkest clouds looming over the market show glimmers of parting”, says Reshma Kapadia in Barron’s. Regulators are said to be winding up a probe into ride-hailing service Didi, which was launched last year after the firm defied authorities and listed in New York. That may also mean the end of a ban that has prevented it from signing up new users.

Foreign investors have been net sellers of Chinese stocks since March, but snapped up $5.5bn worth of equities listed in Shanghai and Shenzhen last week, says Hudson Lockett in the Financial Times. The CSI 300 benchmark has rallied 13% since a low early last month.

Still, signs of more market-friendly policies are not about soothing investors’ feelings, says Shuli Ren on Bloomberg. “The recent regulatory easing is most likely intended only to create jobs.” Tech, media and education firms are vital employers of recent graduates, a new batch of whom will join the job market in July. “The government’s many objections toward tech companies, from antitrust to data security, have not changed. Their business models are still on shaky ground.”

Shanghai, China’s biggest city, “has spent most of the past two months in a state of suspended animation”, says Nathaniel Taplin in The Wall Street Journal. Yet despite growing economic damage from a prolonged lockdown, policymakers have brought in only modest stimulus measures, perhaps because they think that “revving the monetary engine with much of the economy in partial lockdown might… simply blow asset bubbles”.

Until China “finds a way out of the zero-Covid labyrinth it has built for itself” an “extended period of subpar… growth” looks likely. The economic damage is becoming apparent. Chinese retail sales fell 11.1% compared to a year before in April, the sharpest slowdown since the initial coronavirus wave in Wuhan in March 2020. Sales of new homes are down 42%, with housing starts down by more than 44%.

“China’s economy performed a stunning feat in 2020,” says Tanner Brown in Barron’s. After shrinking 6.8% in the first quarter, the subsequent rebound was so strong that the country ended 2020 as the only major economy to register any growth. Yet a repeat this time looks harder. The property market, which accounts for nearly 30% of GDP, has been weakened by “numerous debt defaults”. The open-ended nature of zero-Covid policies is deterring investment: nearly a quarter of firms polled by the EU Chamber of Commerce in China are considering shifting investments out of the country.

Investors recalibrate

Zero-Covid uncertainty, geopolitical tensions and a regulatory crackdown on big tech firms have driven the CSI 300 stock index down 19% so far this year. The Golden Dragon Index, which tracks US-listed Chinese shares, has fallen 58% over the past year. The golden dragons’ days may be numbered, though: this week ride-hailing group Didi notified the New York Stock Exchange of its plans to de-list. The move comes as Beijing looks to assert more control over Chinese firms with foreign listings.

There is still “money to be made” by those who keep on the right side of regulators, says Sofia Horta e Costa on Bloomberg. Yet Beijing’s “opaque and unpredictable decision making” is making traders jumpy. This month, Alibaba lost $26bn in value within minutes after a man who shared co-founder Jack Ma’s surname was accused of endangering national security (it turned out to be a different Ma).

There is now a debate about whether Chinese securities have become “uninvestible”, says The Economist. It’s more accurate to say that they have become “unanalysable” – it is hard to price all the geopolitical risks. “Unfortunately, few assets these days are entirely free of such risks”, as the Ukraine-driven surge in commodity prices shows. Stockpickers will need to start taking “a broader view of the world”.

SEE ALSO:

Why China's Covid lockdowns will be the next big shock for global growth

I was lucky enough to attend the Students for Liberty conference, LibertyCon 2022, in Prague last weekend.

Oh, my goodness. What a beautiful city is Prague! I’d never been before, but I shall be returning ASAFP.

While there, I heard a talk by Li Schoolland, a Chinese-American businesswoman, who is the director of external relations Asia Pacific for the Acton Institute. She fled China in 1984, having survived Chairman Mao’s Cultural Revolution.

She made the case that China, not the US, is the “paper tiger”. What did she mean and what does it imply for investors and the Chinese economy?

China is in trouble

The expression “paper tiger” is used to describe something that appears powerful or threatening, but is in fact weak and vulnerable.

The term was made famous by Mao Zedong, the notorious chairman of the Chinese Communist Party and founder of the People’s Republic of China, in 1957. He said: “All the reputedly powerful reactionaries are merely paper tigers. The reason is that they are divorced from the people.

“Look! Was not Hitler a paper tiger? Was Hitler not overthrown? I also said that the tsar of Russia, the emperor of China and Japanese imperialism were all paper tigers. As we know, they were all overthrown.

“US imperialism has not yet been overthrown and it has the atom bomb. I believe it also will be overthrown. It, too, is a paper tiger”.

There’s rather a lot to unpick there. As time is of the essence, we shall ignore that classic of the Godwin’s Law genre (whoever mentions Hitler first loses the argument), as well as the hypocrisy of criticising authoritarian rulers for being divorced from the people.

Schoolland’s main argument was that today China’s regime is “divorced from the people” and so is a paper tiger. As an authoritarian, corrupt and often incompetent planned economy, it is vulnerable. The events of the past week would seem to bear her out.

“Don’t buy Chinese stocks!” she said. There are so many frauds. Many exist solely to secure funds, with no operating business behind them. Over 60% of China’s market capitalisation is state owned. “If you buy stocks, you are supporting an authoritarian regime.”

Even something like TikTok (ByteDance is the parent company) is “under the regime”. I’ve been unable to verify this: but Schoolland argued that, never mind its use as a surveillance tool, if you read the small print, then once uploaded, your videos effectively become the property of the Chinese state.

Like TikTok, central bank digital currencies (CBDCs) – a field in which China very much has the lead – are a useful surveillance tool. Those tools will now be used on all those athletes who downloaded money apps during the Olympics. As well as to control, they will be used to market stuff. The app will know if you need a loan, say, as well as what type of loan and what your circumstances are, and so will begin marketing financial products to you.

Property is no better as an asset class. Over 30% of the build cost of a property in China is government bribery, she says. I’m not quite sure how you verify that figure, but it doesn’t sound implausible.

Meanwhile, despite all the pictures you might see of amazing buildings in China’s cities, says Schoolland, more than 43 million people still live on less than a dollar a day – although that has come down from more than 100 million in the 2000s.

China is heavily indebted too, which makes it vulnerable. Its debt-to-GDP ratio, Schoolland argues, is greater than the stated 70%. It’s closer, in fact, to 275%.

Shanghai is unravelling with the extended lockdown there. Supply chains are breaking down. There is much discontent and, Schoolland insists, revolution is very much in the air. China needs a new system, not just a new leader, she says.

How to play China’s efforts to revive growth

The evidence of the past few weeks hints that Schoolland may well have a point.

Supply chains have been disrupted, inflation is biting – especially in food and energy prices, interest rates are being held down, the currency is at its weakest since late 2020, international funds are selling out of Chinese assets, attempts to lure domestic investment into capital markets aren’t working, the stockmarket is down by over 20% this year – and a slowing property market is also eroding wealth.

On top of everything else, the evidence of the last two years is that viruses are beyond government control, and that lockdowns do more damage than good. Nevertheless, President Xi Jinping remains committed to “Covid zero”. Irony of ironies, he blames Covid on the germ warfare of “US imperialism”.

But you can’t just ignore China as an investor; it’s too big. The way to play it, for me, is to be in the business of selling it stuff.

Xi has committed to boosting infrastructure construction to bolster the economy. Planned investment this year amounts to at least $2.3trn, according to Bloomberg. Load up on base metal mining stocks, is my advice.

The People’s Bank of China has declared it “will promote the healthy and stable development of markets and provide a good monetary and financial environment” and that “liquidity will remain reasonably ample”.

We are back to that centrally-planned economy thing again. Oh dear.

But that money has to go somewhere.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.

“Chinese stocks are on a roller coaster”, says Paul La Monica for CNN. The country’s tech shares had plunged in recent weeks, with the Nasdaq Golden Dragon index of US-listed Chinese tech plays down 38% during the month through 14 March. Beijing’s crackdown on tech firms, “worries about leading Chinese companies possibly getting delisted in the United States” and a surge in domestic Covid-19 cases had all weighed on sentiment.

On 16 March, regulators came to the rescue. A top financial policy committee chaired by vice-premier Liu He announced that the government would “actively roll out policies that benefit the markets”. Investors took it as a “trend changer” and Chinese stocks had their best day since 2008, says Ipek Ozkardeskaya of Swissquote. The Golden Dragon index soared almost a third, while the Hang Seng Tech index leapt 22% in Hong Kong.

Starting to worry

The change shows “how worried policymakers have become about the markets, real estate and the economy”, says Bill Bishop in the Sinocism newsletter. The announcement is clearly a signal that regulators “don’t want markets to go down more”. Still, investors shouldn’t bet on a complete end to a crackdown that has hit the likes of Alibaba and ride-hailer Didi. This may mark “more of a calibration to stabilise things” rather than a “real shift”.

China’s “techlash” has led to “colossal value destruction” for investors over the past 18 months, says The Economist. “Liu’s statements are the strongest signal so far” that this pressure is ending. That may mark a bottom, but it won’t reverse the losses that investors have already sustained. Shares in tech giant Tencent gained $112bn in two days, but are “still down by around half” since their early 2021 peak.

Geopolitics also looms large. “Something big is happening in global capital flows”, says Robin Brooks of the Institute of International Finance. “China… is seeing big capital outflows, while the rest of [emerging markets] gets inflows.” That has “never happened before on this scale and reflects asset managers looking at China in a new light after Russia’s invasion of Ukraine”. The rush to exit Russian assets is making some reconsider Chinese holdings as well.

Optimists are hoping that “last year’s bruising clashes between the state and the stockmarket” are over, says Leo Lewis in the Financial Times. Previous “confidence-boosting” measures like this, such as after the global financial crisis, have turned markets around before. But those happened in an era “where globalisation still felt fundamentally unstoppable”. Today, talk of de-coupling and shorter supply chains makes that seem less certain. Chinese markets will increasingly be a “proxy for investors’ views on the future of globalisation”.

“As the Chinese year of the tiger begins, the… market is set to really bare its teeth,” says Kate Marshall of Hargreaves Lansdown. In 2008 China accounted for 15% of the emerging market stock index, but its shares have since risen to one-third. “Chinese middle and upper income groups are forecast to expand by over a third of a billion people by 2030,” roughly equivalent to the US population. Not for the first time, Asia looks set to be the “engine of global growth”.

Chinese stocks had a terrible 2021

Despite that, “Chinese stocks had a terrible 2021”, says Jacky Wong in The Wall Street Journal. A regulatory crackdown on education and tech stocks – “Alibaba lost nearly half of its market value in 2021” – combined with a slowing property market saw the large-cap CSI 300 index finish last year down 5%.

Yet 2022 may be better. While most central banks hike interest rates, China has eased monetary policy in recent months to cushion the effects of the property downturn. That should provide a “tailwind” to equities, which look cheap: on 12.1 times forecast earnings, the MSCI China index trades below its five-year average valuation.

Wall Street is almost entirely bullish, agrees Sofia Horta e Costa on Bloomberg. Marko Kolanovic of JPMorgan forecasts that the MSCI China index will “surge almost 40%” this year. “That bet isn’t going so well.” The CSI 300 fell 7% in January and entered a bear market, having fallen 20% since a February 2021 peak.

The ongoing property market fallout, earnings downgrades and Omicron restrictions are keeping the market subdued for now, says Sean Taylor of DWS. But come the second quarter “targeted government support” will boost growth and should see stocks start to outperform.

Big tech is out of favour

China may also dodge the West’s Covid-19 hangover. While debt has soared elsewhere during the crisis, China’s non-financial-sector debt fell by 7% to 265% of gross domestic product by the third quarter of last year. The “de-leveraging” campaign that has hit the property sector is bearing fruit. “In the last Year of the Tiger, 12 years ago, China successfully overtook Japan as the world’s second-largest economy.” This year could bring a similar leap in markets.

The upcoming Winter Olympics and a busy political year should see Beijing prioritise stability in 2022, says Reshma Kapadia in Barron’s. That “lowers the odds of further dramatic regulatory crackdowns”. Still, “the online businesses, e-commerce companies and gaming” stocks that dominated the last decade are now out of favour, says Pradipta Chakrabortty of investment manager Harding Loevner. Instead, the climate favours smaller firms in sectors such as industrials, healthcare and IT, says Kapadia.

There was just one official outcome from the Sixth Plenary Session of the 19th Central Committee of the Chinese Communist Party earlier this month. More than 300 top members of the party met for the last time before next year’s national congress to approve a resolution on the party’s history and achievements – essentially a document that talks at great length about how hard the party has worked, how much it has done for the people and how it will keep up its efforts in future.

That may seem a scant return for a four-day closed-door meeting, but it has symbolic significance. This is the third time that a Chinese leader has issued a resolution on the party’s history: Mao Zedong did so in 1945 and Deng Xiaoping in 1981. By doing the same, Xi Jinping elevates himself alongside them in the pantheon of leaders, ahead of his predecessors Jiang Zemin and Hu Jintao. Xi is mentioned 17 times in the resolution, compared to seven for Mao, five for Deng and one passing mention each for Jiang and Hu.

The signal is clear. Not only will Xi continue as leader next year (there was no real doubt about this), but he represents a new era for the country, shaped solely according to his vision. The future is Xi’s China, for better or worse. The problem is that the trends increasingly say that it will be for worse.

Running out of time for reforms

There are three distinct – though closely connected – reasons to be concerned about the outlook for China. The first is the structural weaknesses of the economy. Economists and investors have been talking for many years about the need to rebalance from investment towards consumption. The problem is that this isn’t happening. Private consumption only accounts for around 39% of GDP, up from 35% a decade ago.

If China was investing productively, this would be less of an issue – but it’s clearly not. You can see this in a number of areas, but one of the most important and high-profile areas is residential real estate. This accounts for around 29% of GDP when you factor in everything connected to it. There is little question that there is a huge real-estate bubble and a lot of very indebted developers building properties that are often purchased for investment rather than use (about 20% of Chinese residential real estate is reportedly empty).

The Chinese government is very much aware of this and wants to curb the excesses in the sector – hence the public crackdown on real-estate lending earlier this year, which has brought a number of developers such as Evergrande to the brink of failure. The difficulty is that squashing a bubble like this isn’t simple – the economic linkages are complex and actions can have far-reaching consequences.

Most obviously, the collapse of developers affects anybody who has lent to them, suppliers who are waiting to be paid and buyers who have paid for off-plan properties that may not be completed. However, bursting a wider bubble in the sector will affect the wealth of people who have bought property, with effects on consumer confidence. Less demand for new land from developers will affect local governments, who in China need to cover much of their spending and investment from land sales rather than taxes or issuing bonds. The government is not blind to this. For example, last month it announced a pilot programme under which around ten cities will levy property taxes, with the idea of introducing it nationwide after 2025. This could put local-government finances on a sounder footing, making them less dependent on the property and land price bubble, and generally reducing the outsize role that the sector plays in the wider economy.

But many changes are not easy, quick, certain or controllable. The government’s efforts to squeeze the sector may not go far enough, in which case unproductive real-estate investment will continue to be a long-term faultline in the economy, even if it helps to support growth for now. Or they may bring everything crashing down fast. In the last two months, property prices have fallen for the first time since 2015, which some analysts already fear could be the start of a slump that will spread to the wider economy.

Real estate is just one problem, albeit a very large one. There are plenty of other poor-quality investment by state-owned companies or local governments. The economy would be a lot sounder if this spending was instead flowing to individuals and households as income. None of this is a new idea – and Xi’s flagship policy of common prosperity aspires to spread wealth more equally. However, the details of how this will happen are non-existent and China’s window for dealing with these profound problems is shrinking because its demographics are becoming increasingly unhelpful. A decade ago, the dependency ratio – the ratio of old and young to working age people – was 34%. Now it is 42% and set to climb faster.

This will naturally bring down the long-term sustainable growth rate. Transitioning from a model driven by lower-quality investment towards a more balanced one isn’t painless in the most favourable conditions, but it will feel even harder when the economy is growing more slowly. So the temptation to prop up growth through yet another round of investment is likely to become even greater if GDP drops to 3% (which might be the sustainable rate) instead of 6% in the years ahead. In short, the longer that China puts off real change, the harder it may be.

The heavy hand of the state

The second concern is the heavy hand of the state in all areas of the economy and society. Xi and his key advisers clearly believe that China has taken the wrong path. There are aspects to their vision that could be positive, at least in principle. For example, it is likely that Xi’s wide-reaching anti-corruption campaign reflects genuine personal disgust with the level of corruption in modern China rather than a simple pretext to purge political rivals. That’s not to say the campaign is well-conducted: it creates a climate of fear, it has served to crush opposition to him, and it does nothing to bring about the transparent and predictable rule of law that China badly needs. But the ambition of tackling corruption is understandable.

Similarly, the crackdown on high-flying tech companies such as Alibaba that began last year is reasonable in many ways. These firms had grown very large, very powerful and often quite monopolistic, due to their success in skirting ineffective regulation. Taking action against them might be beneficial for the wider economy even if it hurts shareholders in those individual firms. The problem is the suddenness, the lack of clarity in terms of the government’s long-term intentions and the abrupt reminder that private property rights are ultimately very limited.

China never gave up on the idea of a large role in the economy for the state, but it is unambiguous that Xi’s administration sees the state as far more dominant than under his recent predecessors . Whenever there is a situation in which the government feels that private businesses are not serving its social goals, it will step in. Sometimes this is survivable. After Alibaba’s time in the spotlight, Tencent took a beating over concerns that children are playing computer games too much: it and its rivals must now restrict access for children to just three hours a week at specific times. That’s unwelcome for games companies, but not a fatal blow.

However, when the government decided to outlaw for-profit private schools for children earlier this summer, it destroyed a thriving private educational sector. US-listed shares in New Oriental Education & Technology, the largest and best-known provider, began 2021 at $17 and now trade at around $2. This decision was directed at the wide use of after-school classes and private tutoring by ambitious parents, which the government says puts too much pressure on children. The government also apparently hopes removing the social pressure to pay for expensive private tuition will raise the birth rate and eventually alleviate the country’s demographic crunch (the expense of raising children is often cited as a reason why many people remain reluctant to have large families even though the one-child policy has been abandoned). There is certainly a good case that children are under too much pressure and so the aim may be laudable. But the fact that businesses that have been built up over decades can be wiped out so quickly shows how easy it is to end up on the wrong side of the government’s new priorities.

However, the problem goes deeper than control of the economy. Under Xi, the state has cracked down ever more heavily on freedom of speech and discussion of any issues that could be considered sensitive. In the mid 2000s, what could be freely debated or reported had steadily expanded in China. The climate became somewhat more restrictive around the time of the Beijing Olympics and did not fully open up again – but in recent years the shift towards repression has become far more severe. Journalists are much more restricted in what they can report and censorship on social media has become stricter. Newspapers are now full of fawning articles about Xi’s virtues and vision.

The ability to debate policies is constrained even in academia, while high-profile critics who might previously have enjoyed some element of protection because of their status and connections have been silenced. Real-estate tycoon Ren Zhiqiang, who had been a blunt critic of Xi and the party, was last year jailed for 18 years on allegations of corruption, in what was widely seen as a warning to others.

Obviously, to anybody who values freedom of speech, this is appalling. However, it’s also bad for China regardless of the human-rights issue. Shutting down the ability to report, discuss and debate increases the risk of making mistakes. Policies are not publicly scrutinised, while the information reaching top decision makers become more one-sided.

The third concern is international relations...

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The saga of China’s heavily indebted property market is not going away.

Evergrande – the one that’s most obviously in the firing line right now – failed to make a payment on a dollar bond that was due yesterday.

It now has a 30-day grace period before it’s actually deemed to have defaulted.

So what happens now?

Evergrande has missed a bond payment

Yesterday China Evergrande failed to make an $83.5m coupon payment on some of its outstanding dollar debt.

This isn’t really a huge surprise. The company’s bonds are trading at a massive discount to their face value – what does that mean in English? It means that no one believes that Evergrande’s IOUs – particularly IOUs to foreigners, rather than Chinese citizens – are worth very much.

What’s the point? The point is people knew this was very likely to happen. Evergrande needs to restructure its debt; it owes too much money to too many people and it has virtually no way of raising cash to pay them. So that’s a given at this point.

Also, Evergrande has been in trouble for a long time. So anyone – particularly outside China – who has money there, should have been aware of the risks. As Udith Sikand of Gavekal Research points out: “With Evergrande’s US dollar denominated bonds currently trading at around 30 cents on the dollar, offshore investors are clearly pricing in a brutal haircut for institutional creditors.”

In other words, Evergrande will be coming to a deal with the people it owes money to, which will involve them only getting some of it back (right now, markets are guessing not much more than 30%).

So a lot of this is “in the price” and chances are, if you’re reading this, you probably don’t own any Evergrande bonds. So what’s the worry?

We’re moving into a much more fragile market environment

As I noted last time I wrote about this, despite all the headlines, markets have been quite relaxed about all of this. It’s partly because there’s still a belief that the Chinese authorities are capable of stepping in to sort this out.

Well, what we’re all worried about here are the knock-on effects.

Most people reckon it’s not “Lehman Brothers”. And I think that’s a reasonable thing to say. It seems highly unlikely that the rug will be ripped out from under Evergrande. China’s authorities (and global regulators) are highly aware of 2008 and they don’t want sudden shocks. They’ll be looking to avoid systemic risk – already the Chinese central bank is pumping a bit more money into markets.

The thing is though, just because we’re not going to get a repeat of 2008, doesn’t mean that everything is fine. “At least it’s not a once-in-a-generation financial crisis” is quite a low bar to beat.

One problem is that Evergrande is not alone; it’s hogging the limelight, but the Chinese property sector overall has been hit hard by a general crackdown on the sector. This arguably isn’t yet reflected in prices.

So one risk, notes Sikand, is that the Chinese authorities make foreign bondholders take a bigger haircut than onshore ones. You could then get a scare which leads to a big sell-off in the bonds of other Chinese property developers, for example. This could lead to much tighter credit conditions for emerging markets more generally.

Does that matter for your portfolio? Again, it’s hard to judge until we see how it all starts to unfold.

A big dent to China’s economy would usually be bad news for commodity prices, but given that we’re all short of so much stuff at the moment, it’s possible that China isn’t currently the biggest driver of that market anyway.

So it’s messy, and it’s not easy to read, but all in all, I still think this is a slow-burn issue. But what I would point out is that this is all happening at a time when wider markets are bracing for developed-world central banks to embark on a monetary tightening cycle. It’s also happening at a time when wider markets are not exactly cheap.

So it does feel as though we have a relatively fragile market environment where the participants have been drugged by a decade of monetary policy support into thinking that there is no alternative but to “buy the dips” because someone will always step in to make any risks go away.

Yet at the same time, we are moving into a far less forgiving environment for both investors and for the authorities. Evergrande may not be the straw that breaks the camel’s back, but the poor old beast of burden is looking pretty weighed down right now.

We’ll be looking in more detail at these risks in future issues of MoneyWeek magazine. You can currently get the Kindle version of my book, The Sceptical Investor, free when you subscribe to MoneyWeek, and you get your first six issues free too – just sign up here.

“A wave of fear over Chinese economic growth swept through global markets on Monday,” say Narayanan Somasundaram and Jack Stone Truitt on Nikkei Asia. Markets dropped in Asia, Europe and the US, where the Dow Jones Industrial Average at one point fell 972 points (almost 3%) before paring losses to 1.8% before the close. Behind the bout of jitters lay the fate of Evergrande, China’s most indebted property developer, which is teetering on the brink of default.

An Evergrande bankruptcy would “amount to a financial tsunami”, says Caixin. The firm has ¥2trn (£227bn) in known liabilities (about 2% of China’s GDP), plus unknown amounts of off-book ones. Some analysts say it could be “China’s Lehman Brothers”, referring to the 2008 collapse of the US investment bank that helped trigger the global financial crisis.

Risks are manageable

That’s an exaggeration, say analysts at Barclays. Evergrande is big and there will be consequences for China’s real-estate sector. “But a true ‘Lehman moment’ is a crisis of a very different magnitude.” It would entail a “lenders strike” across the financial system, a “sharp increase in credit distress” outside real estate and banks not being willing to lend to each other in the interbank market.

Evergrande won’t cause that. First, its financial-system liabilities are much smaller than its headline liabilities (more than half the total is what it owes to suppliers) – it has around ¥227bn in bank loans and about ¥158bn in offshore and onshore bonds. Second, China has “navigated successfully through a number of defaults and restructurings” lately, including the financial conglomerate Huarong, which had about ¥1.4trn in liabilities. There’s no reason to expect policymakers to mess up this time. Third, Evergrande – and other Chinese property firms – aren’t at the mercy of wholesale funding markets, as Lehman was. “In an extreme scenario where capital markets are shut to all Chinese property firms … which is not occurring … regulators could direct banks to lend to such firms, keeping then afloat.”

Unpredictable consequences

The crisis is not a Lehman moment, concurs Bill Bishop in his Sinocism newsletter. “But it is ugly and will get uglier.” It’s rash to assume policymakers “have a full understanding of all the Evergrande liabilities and interconnections with other firms” Some form of bailout will happen, but “the lack of guidance from regulators seems to be spooking investors”.

This “is far from being a well-managed process”, agrees The Economist – hence bonds from other developers such as R&F, Fantasia and Sinic have slumped over fears they may be next. The underlying issue is that Xi Jinping, China’s president, is cracking down on excess debt in real estate as “one of several campaigns [he] is using to remould the country”. So the contagion risks aren’t just about markets. Real estate accounts for 20%-25% of GDP, thus “an extended campaign against developer debt could significantly lower China’s growth prospects... and lead to greater economic and financial turmoil down the road”.

Before we get started this morning, I just wanted to let you know that early bird tickets for this year’s MoneyWeek conference are now available! Grab yours now! Given what’s going on in markets this very day, I think you’ll want to make sure you attend: here’s where to book.

So now onto the main topic – you might have noticed that markets were feeling a bit jittery last week. Turns out that they’re finally waking up to what’s going on with troubled Chinese property developer Evergrande.

The collapse has been a long time in the making, but now we are very much in “push comes to shove” territory.

Whatever the Chinese government has planned, we’re likely to find out this week.

Why the Evergrande situation is likely to come to a head this week

Evergrande has been described as China’s Lehman Brothers. It’s a big, heavily-indebted company whose debt has trickled into lots of parts of the economy in a fairly opaque manner. That debt is tied to property markets and house prices, which have been sliding in recent months as China has cracked down on speculation.

So the fear is that if China just let Evergrande go bust then we’d have something similar to what happened after 2008 in the US.

The obvious retort to this has been that 2008 set the strategy book for every other possible crash – for governments and central banks to step in and bail everyone out. That eventually happened after 2008. It eventually happened after the eurozone crisis. It happened during the pandemic (see below). And the assumption has been that it would happen for Evergrande.

However, while Beijing has been doing some stuff behind the scenes (injecting money into the system on Friday for example, and lining up some restructuring specialists for Evergrande), a grand bailout plan hasn’t been unveiled yet. And markets are now getting nervy.

One problem with these things is that it’s much better to step in before a run gets going. The Federal Reserve’s actions in 2020, at the height of the pandemic panic in markets, show that the US central bank has taken that lesson to heart. At the first sniff of credit markets shutting down, the Fed just went all-out to underwrite the entire market, and not just in the US.

Yet the problems with Evergrande are starting to creep into the rest of the Chinese property sector, because people are waking up and realising that this is not just about Evergrande – lots of companies build or sell houses, and houses just aren’t selling right now.

So why does it seem likely that a solution will come this week? Well, as Eoin Treacy of FullerTreacyMoney.com points out, the Chinese holidays (the market is shut on Monday and Tuesday) make this a pretty good week for the authorities to step in – while markets are shut – to make their move.

But more importantly, Evergrande has interest payments to make on two notes on Thursday. They’re not expected to be paid, but some sign of the Chinese government erecting a firebreak to prevent “widespread contagion” might be forthcoming.

John Authers puts it well when he says in his latest Bloomberg newsletter that Evergrande is more likely to be an LTCM moment rather than a Lehman one. He’s referring to the US bailing out giant hedge fund Long-Term Capital Management in the late 1990s, rather than letting it collapse.

Don’t go selling everything

I still think this is probably the most likely outcome. That said, people might well be overestimating the power of the Chinese government. It’s worth remembering that one key reason we favour capitalism and free markets over communism and central planning is because the former is more efficient than the latter.

This is not even politics, it’s just logic. If one person tries to guess what 1,000 people are likely to need for the coming five years and plans supply and demand accordingly, you’re going to get a worse outcome than if those 1,001 people can just interact freely to adjust supply and demand in real-time.

This centralised nature means that Beijing has an awful lot of competing and conflicting priorities, and there’s a lot of complexity to deal with here. Lots of stuff could go wrong. So that’s why I’m loath simply to rule out something more akin to a Lehman Brothers moment, even if it’s not my central scenario.

But what does it mean for you as an investor?

As I said last time, I still don’t think there’s any point in you making big changes to your portfolio over this. To be clear, when I say this, I’m making some big assumptions. I’m assuming that a) you have a clear view of your own asset allocation; b) that you have a clear long-term investment plan (ie how much do you need, what for, and by when?); and c) that you are up to date with these things.

If you’re not nodding along to all or any of those points, then you should take some time to resolve them. You certainly shouldn’t be trying to second-guess the Chinese government when your own investment housekeeping isn’t in order.

That’s not me guilt-tripping you about your admin, it’s just that if you don’t know what your plan is, then you’ll make short-term mistakes and you’ll almost certainly lose money by doing so.

With all that said, there are probably two main ways this can go. One is that China – through overconfidence or recklessness or a surfeit of communist joie de vivre – simply steps back and lets the cards fall where they may. Put bluntly, that would terrify everyone.

That said, if you’re living and investing largely outside of China and its sphere of influence (which you most likely are) then you have to remember that even if China’s authorities don’t step in, then our own are likely to do so if it looks as though there’s a serious risk of contagion outside China.

Moreover, if China does step in with a convincing bailout package, then there’s every chance that investors decide it’s “off to the races” time again, just as they did when the eurozone crisis finally had a line drawn under it.

In the longer run, a slowdown in the Chinese economy is something that global markets will have to contend with, but we can discuss that at a later date.

For now my point is this: Evergrande might be scary and you will see some scary headlines. But if you have a plan you’re happy with, there’s no reason to change it. And you certainly shouldn’t flog everything and jump to 100% cash because if you don’t have a crystal ball – that’s pretty much never a good idea.

If you haven’t already, book your ticket for the MoneyWeek Wealth Summit in November – it’s virtual, but I’ll be there with Merryn, so we’re likely to have a better idea of the outcome by then – so you can ping me all your difficult questions on it, on the day.

BlackRock, the world’s biggest asset manager, announced in May that it was very keen on China, which, it told us, had “emerged from the pandemic with renewed confidence”. Its economy and market had both nicely outperformed during the crisis, something that “deepened” BlackRock’s view that it could expect “relatively better returns for Chinese assets over peers”.

It is early days of course. We must never judge an investment call on three months’ performance, but so far this is not going well. Not at all. When I run my eye down a list of my investments, the one that stands out from a long list of pleasant positive numbers is the Fidelity China Special Situations investment trust. It is down 15% in the past three months.

It is not alone in its misery; look at the worst-performing funds and trusts in the UK and you will find most are China-focused. The clue to what has gone wrong here is embedded in the BlackRock gush: “a stable economic background has made authorities more comfortable emphasising structural reforms over short-term growth targets”. That’s true; it has. It’s just that it turns out that the market is not comfortable with quite the same things as China’s leaders.

There were hints that there might be a problem brewing last year with the halting of Ant Group’s IPO and ban on ride-hailing firm Didi Global registering new users a mere two days after its US IPO. At $4.4bn, the valuation was naturally based on it registering new users.

China’s crackdown spreads beyond Big Tech

But we are now well beyond the hinting stage. In late July the once highly profitable tutoring companies in China were told they are no longer allowed to make profits. The market cap of the sector was about $100bn at the start of the year. It’s now more like $10bn. Why it now has any value at all is something of a mystery given that the value of a share is based on the expectation of the distribution of profits, and here we have companies banned from making profits.

These specific examples now look to be the tip of a looming iceberg. This week we’ve seen announcements of new rules about how Chinese kids, companies and celebrities should behave.

Tech companies that can influence public opinion have been told to register their algorithms with the government: they must work to “spread positive energy”. Delivery companies have been hit by demands that all workers must get the local minimum wage. Parents are to lose more of what little agency they still have over their children, with the state mandating a limit of three hours a week using the “electronic drugs” that are video games, enforced by facial recognition technology. And “irrational fan culture”, as officials put it, is no longer to be allowed: popularity charts for the biggest Chinese celebrities have been removed from microblogging site Weibo, for example.

This is all in the name of what Beijing calls “safeguarding the internet’s political security and ideological security” as well as providing a “safe spiritual home” for the general population. As opposed to a safe home for tech stock profits...

There’s more. President Xi Jinping isn’t just after safe spiritual homes for Chinese people, he’s after providing more equal homes. Enter the announcement that he intends to “regulate excessively high incomes”. That’s been a shock to the share prices of the world’s luxury goods companies: Chinese consumers buy a good 40% of their products and, as anyone who has ever browsed the products of LVMH will know, you need an excessively high income to even drag up the courage to enter the store.

“Experts” say it’s fine – but it’s really not

Maybe this is all OK. JPMorgan reckons you can still “navigate” the Chinese market on the basis that there have been “clear domestic motivations” for each destabilising action. The move against Ant was to rein in shadow banking; that against Didi was to protect data (data protection in China has been weak); and that against the for-profit education sector to “ease the financial burden on households to incentivise higher birth rates”.

Most other analysts appear to think the same: the worst is over and China will now move into a “compliance phase”; companies will adapt, and that will be that. This is possible, but even if the policies have a clear agenda behind them, that doesn’t bring the profits back – and given what we know about how government intervention tends to destroy innovation, it seems unlikely to foster new ones either.

It’s also fair to say that analysts predicting there will not be another round of new regulation did not help their case by failing to predict the first one. After all, if tutoring companies can be told that it is their job to make life cheaper for families, why not tell housing and healthcare companies the same – note that only a few days ago the government moved to cap rises in rents. “Renewed confidence” sounds good, but I’m not sure that this tsunami of totalitarian speak and OTT legislation represents the kind of state confidence that works for stockmarkets.

You’re probably already exposed enough to Chinese stockmarkets

Still, there is no such thing as an uninvestable market, only a market that isn’t priced to reflect its risks. You could argue that many Chinese equities are now cheap enough that the risk really is in the price. Tencent and Alibaba, for example, now trade at major discounts to US tech groups, which aren’t exactly 100% free of state interference either.

Compare the two and you might be a big buyer. However, before you fall for that bit of relativity consider another bit. I’ve mentioned the Russian market in the past. When it was on a price/earnings ratio of about five to six times, I noted that it was not just priced as an emerging market but pretty much discounting a return to communism, something that was unlikely. I bought some shares.

China may be jammed full of potentially high-growth companies, but it still isn’t priced to reflect the unpredictability of a government that can already be as communist as it likes. With that in mind note that the cyclically-adjusted price/earnings ratio for Russia is about ten times.

It’s 17 times in China, about the same as in the UK, where I would argue political risk is rather less of a problem. We all probably have Chinese exposure via our pensions and any global growth funds (Alibaba, Tencent and Meituan alone make up 12% of Scottish Mortgage Investment Trust’s portfolio – which I also own – for example). That’s probably enough.

Like most people, I am not certain of much about China, but one thing I know is this: when its government refers to “prosperity for all”, the definition of “all” does not include me – or you.

• This article was first published in the Financial Times

What’s happened?

There’s a growing sense that foreign multinationals and investors have underestimated the risks of doing business in China and overestimated the benefits. From reining in tech billionaires such as Jack Ma, to making life harder for multinationals trying to access the Chinese market while staying on the right side of Beijing, all indications are that China under Xi Jinping is increasingly prioritising absolute control by the Communist Party of China (CPC) over further economic liberalisation. The first big red flag came last November when financial regulators suddenly suspended the IPO of Ma’s Ant Financial, days before its listing in Hong Kong and Shanghai. Warning bells have been ringing ever since.

Such as?

One that spooked investors was the tightening in late July of regulations governing China’s $100bn private tutoring industry, banning firms that teach the school curriculum from making a profit. Specifically, the worry concerns a new ban on Chinese tutoring companies using a corporate structure known as the variable interest entity (VIE). That’s essentially a holding company aimed at circumventing the strict rules banning foreigners from owning assets in key sectors, such as technology – and it’s long been a primary channel for foreign investment. Both Beijing and big Western institutional investors, such as BlackRock and Fidelity, have until now been “happy to gloss over the risks of the strucure”, says the Financial Times. That no longer looks so wise.

What else has got people worried?

Earlier this year China passed a new data security law that forbids firms from handing over any data to foreign officials without government permission. It strengthens the authorities’ already vast powers to intervene in individual businesses, by compelling them to share data collected from social media, e-commerce, lending and other businesses, and classifying such data as a national asset. The New York listing of Chinese ride-hailing firm Didi was a salutary reminder to investors of the political/regulatory risk involved. No sooner had investors put $4.4bn into the biggest Chinese IPO in the US since Alibaba in 2014, than China’s internet regulator accused it of “serious violations of laws and regulations” in collecting and using personal information.

Why was that so important?

The developments at Didi amount to “a shock-therapy type of enforcement”, says Benjamin Qiu, a Hong Kong lawyer. “We could see more control by the state, with in-effect data nationalisation as the end result.” The Didi fiasco was a particularly “painful reality check” for any Western investors complacent enough to think that “long totalitarianism” was a smart trade, says Niall Ferguson on Bloomberg. It has been clear for years that the symbiotic relationship between China and the US is fracturing, and that the CPC’s core goal is not “global economic dominance” but retaining domestic power. As China’s demographics bite, and its growth slows, that task will get harder while the “Cold War” between China and the US gets more pronounced. All that means increased risk for investors and businesses.

How will that manifest itself?

Sometimes it will be in obvious ways. For example, with a new law aimed at punishing Western companies that comply with US sanctions – and which is expected to be extended to cover business based in Hong Kong. That could leave Western multinationals stuck between complying with US regulations and getting sued in China. On other fronts, the risks are increasingly more subtle. Take China’s cinema industry, which has bounced back strongly this year and is by far the world’s biggest theatrical marketplace. But the slice taken by US releases has slumped, according to The Hollywood Reporter – in part because the ban on foreign film releases during the peak summer period has been stricter and longer than usual in deference to the 100th anniversary of the founding of the CPC. Or consider the speech last month by Xi attacking wealth inequality: it sent the share prices of Europe’s big luxury goods businesses reeling (see page 5). In 2021, China’s shoppers are expected to buy 45% of all the luxury goods sold globally, according to Jefferies, up from 37% in 2019. A drive by Beijing to rein in the rich would be bad news for makers of posh handbags and investors are reassessing the risks.

Who else is suffering?

Some multinationals are already suffering from collateral damage. Ericsson, for example, the global number two maker of cellular equipment, reported in mid-July that its sales in China had plunged, and warned that its market share there was set to shrink sharply in coming months. The reason, it believes, is Sweden’s decision late last year to ban Huawei from the buildout of its 5G network. Multinationals in every industry doing business in China “are acutely aware that as the geopolitical environment worsens, all the money and effort they have put into building their businesses there could be at risk”, says Rob Powell in Newsweek. In the worst case scenario, that means confiscation. This week’s uncertainty over the status of Arm China – reported to have declared unilateral independence from its UK-based, Softbank-owned parent – will have added to the fears.

What should investors do?

Prepare for turbulence, says George Soros in the FT. Foreign investors who put money into China find it hard to recognise all these increased risks because China has confronted so many difficulties and come through. “But Xi’s China is not the China they know. He is putting in place an updated version of Mao Zedong’s party. No investor has any experience of that China because there were no stockmarkets in Mao’s time. Hence the rude awakening that awaits them.”

Investors received a rude shock last month when Beijing abruptly changed the rules for US-listed Chinese education companies. With one stroke, shares in TAL Education and New Oriental Education and Technology became almost worthless. The Nasdaq Golden Dragon index of Chinese stocks listed in New York fell to half its peak. Investors suddenly realised their legal claims on these foreign listings were extraordinarily weak. Foreign investments on the mainland may not be much safer.

Chinese companies listed in the US used a complex offshore structure known as a variable interest entity (VIE), which allowed them to evade restrictions on foreign ownership of Chinese media and technology groups. VIEs were always a questionable arrangement, neither condoned nor explicitly repudiated by Beijing. Western investors received dividends from the mainland company, but had no legal claim on its assets. This crucial information was in the listing documents. Most investors apparently didn’t read them.

As with the VIEs, Western investors in China pay too little attention to “jurisdictional risk”, says Stewart Paterson of investment-research group Capital Dialectics. While investments in the West are protected by the rule of law, China’s markets are characterised by the “rule by law”: Beijing has the final say on how capital is allocated and who gets paid and who doesn’t. Many companies in China answer to internal party committees that can put the interests of government patrons above those of shareholders. No wonder Chinese equity returns have lagged. In the past five years, the S&P 500 index has gained twice as much as China’s benchmark CSI300.

Red capitalism

Overweening business leaders risk more than just their fortunes. The former chairman of high-flying insurer Tomorrow Holdings disappeared from a Hong Kong hotel in 2017. Agents reportedly dragged him out of the Four Seasons in a wheelchair with a bag over his head. The state has since restructured his company. Last year, Alibaba’s Jack Ma fell from grace and the flotation of Ant Financial was pulled. Ma had accused China’s state-controlled banks of harbouring a “pawnshop mentality”. Property companies who cross Beijing’s “red lines”, capping the use of leverage, are next in line, says Paterson.

Western investors in China’s bond markets face different problems. “Red capitalism” resembles a shell game in which debts are shuffled around the financial system with little regard for legal niceties. For instance, when a wealth-management product issued by a Shanghai branch of Beijing-based Huaxia Bank defaulted in 2012, the losses were picked up by an apparently unrelated credit-guarantee firm. Non-performing loans are often moved from local-government funding vehicles to state-owned banks, and from banks to asset managers. Where losses finally end up is a political decision. The question of which Chinese debts are covered by sovereign guarantee remains murky. This concern is not merely academic. China is in the throes of one of history’s greatest credit booms. Since 2008, the ratio of non-financial debt to GDP has more than doubled to 289%. Several state-owned firms have defaulted on their debts. The national debt, worth 67% of GDP, seems manageable, but when contingent liabilities are included the true figure is probably much higher.

Despite its tough treatment of shareholders in foreign-listed companies, Beijing is still keen to attract foreign portfolio inflows. The mainland stockmarkets opened to Western investors in 2014 and the bond markets in 2017. In 2020 the stock of foreign onshore portfolio investment in China reached over five trillion yuan, up by 400% since 2014. So far this year, foreign purchases of Chinese onshore stocks and government bonds were up 50% compared with 2019, says the Peterson Institute for International Economics.

Westerners are attracted by the size and liquidity of China’s financial markets. The stockmarket offers diversification. Chinese government bonds yield more than their US counterparts. In recent years, index providers have raised both equity and bond-index weightings for China. Asset managers who shun China risk underperforming their benchmarks. Their greatest risk, however, is that they end up as collateral damage in a New Cold War, says Paterson.

Globalisation is slowly going into reverse. Western portfolio investments in China could provide President Xi Jinping with a potential bargaining chip if international relations with the United States and its allies continue to deteriorate. Furthermore, if China’s financial system eventually collapses under the weight of excessive debts, Beijing will have to consider which debts to honour and which to repudiate. The interests of international creditors won’t be a high priority.

When China’s communists took power in 1949 one of their first acts was to repudiate foreign obligations. Fifty years later, a large state-owned investment company, known as Guangdong International Trust and Investment Corp (Gitic), defaulted on its foreign bonds. Investors had assumed that Gitic’s liabilities carried the implicit backing of the state. Nope. Chinese ten-year government bonds currently yield 2% more than US Treasuries. Whether this premium adequately compensates foreign investors for the risk of non-repayment is questionable.

A longer version of this article was first published on breakingviews.com.

Are Chinese stocks “uninvestable”? asks Farah Elbahrawy on Bloomberg. Goldman Sachs says its clients are wondering whether they should pull their money out after Beijing broadened a clampdown on businesses it blames “for increasing inequality and financial risk”. The resulting market volatility has pushed “key stock indexes to the brink of a bear market”.

Investors wake up

Investment trusts focused on China have suffered “average losses of a third” since a recent peak in February, notes David Brenchley in The Times. The benchmark CSI 300 index is down by more than 6% in 2021. “Chinese regulatory interference… is turning out to be one of the big stories of 2021,” says Russ Mould of AJ Bell. What’s next? Keep an eye on “highly indebted” property developer China Evergrande. The shares have tumbled by 63% so far this year as regulators address property speculation.

Investors in China have endured “an excruciating week”, says Seeking Alpha. The “deluge of news” and “speculation” about which stocks would be next in the cross hairs has created a “potent mix of anxiety, fear, anger and regret”. The government’s desire to tackle “social ills and deepening inequality… has parallels”, not least in Washington.

But what has unnerved investors is the speed at which China is announcing new measures. When an authoritarian state makes a decision, things can change very quickly. Beijing has been cracking down on big internet firms for some time, says Thomas Gatley in Gavekal Research. Shares in the likes of Alibaba and Tencent were already having a bad year. What’s changed is that investors have “flipped from thinking” that only a few firms were in trouble to “fretting that no sector is safe”. They may have overreacted. Chinese policymakers were not too worried when the biggest losers were foreign investors (Alibaba’s primary listing is in New York). Yet the latest sell-off has hit domestic investors too, so officials are likely to start treading more carefully. Chinese regulators “hate domestic market volatility”.

Buy the dip?

Some spy a buying opportunity. “We’ve been through these regulatory tightening periods before and generally” they have “been a pretty good time to buy,” Dale Nicholls of Fidelity International tells CityWire. A significant “valuation gap” has appeared between Chinese businesses and global peers. “Chinese tech stocks [listed in the US] have suffered their worst month since the financial crisis of 2008,” says Katie Martin in the Financial Times. For some investors the temptation to “buy the dip” is almost a “reflex”. China bulls say you just need to steer clear of sectors such as education, property and tech.

Most analysts think that the current turmoil will pass. Yet it is still unclear whether the sell-off is over; no fund manager “wants to be the person hauled up in front of the boss at the end of the quarter to explain why they took on more risk just as a well-known bad situation turned worse”. As Morgan Stanley has warned clients: “no bottom-fishing yet”.

Chinese stocks fell hard for a third consecutive session on Tuesday, with Hong Kong’s Hang Seng Index down by more than 5% on Tuesday, Tencent down 10%, Alibaba 7% and Meituan 17% – the most it has ever fallen.

So what is going on?

China’s tech sector came under increased pressure over a crackdown on the country’s private education industry, where a leaked memo proposed a radical overhaul to China’s $100bn private sector education industry.

On Friday, China took punitive measures against Chinese for-profit educators, including banning them from accepting foreign investments, banning them from being acquired, prohibiting them from raising funds via the stockmarket and outlawing them from providing tutoring services on weekends and holidays.

Stocks took a massive hit on Friday after the news, with education companies such as TAL Education and Gaotu Techedu falling more than 50%. But since Friday, the losses have spread to China’s tech stocks.

Why China’s latest crackdown has investors worried about tech

So if China’s latest crackdown was against the education sector, then why did tech stocks take such a big hit? The education sector is separate from tech, but the news is still causing jitters among investors and causing them to flee from tech stocks as well.

China’s latest crackdown comes less than a month after Didi Chuxing, a minicab app in the vein of Uber, was removed from domestic app stores just days after it raised more than $4.4bn in a blockbuster listing on the New York Stock Exchange.

The Didi debacle prompted the Cyberspace Administration of China (CAC) to launch a cybersecurity review into the firm. China alleged that the company – which has a market cap of almost $40bn – illegally collects and uses its customers’ personal data.

China’s crackdown on tech firms was largely seen as an attempt to undermine Chinese firms that have been thriving abroad through public listings – 34 Chinese tech companies have generated more than $12.4bn in New York IPOs since the start of the year.

It’s not the first time China has attacked the sector. In May, China’s competition regulator forced Didi and several other companies to change their practices after claims that the company treated its drivers unfairly.

But it was last November when China really began hitting firms hard when it suspended billionaire Jack Ma’s Alibaba-backed Ant Group’s $34.5bn IPO in Shanghai and Hong Kong. Chinese regulators also slapped the Alibaba affiliate with a $2.8bn fine in April.

So what’s next for investors?

China seems to be leaving no stone unturned in clamping down across many sectors. As the Motley Fool puts it: “Beijing's decision wasn't entirely clear, but it's the latest sign of the government's unpredictability and potential for destroying shareholder value with an unexpected decision.”

“These stocks do look like bargains after the sell-off, but investors should tread carefully for now as further action from the government will only spark further selling,” adds the Motley Fool.

And it emerged last week that global investment banks are rushing to divert Chinese stockmarket listings away from the US to Hong Kong to prevent getting caught up in China’s clampdown on Chinese firms listing abroad.

There may also be a rotation out of Chinese tech stocks into US tech stocks, says Wedbush’s analyst Dan Ives.

Veteran investor Cathie Wood’s flagship ARK Invest Fund has already been offloading Chinese stocks such as Tencent in wake of the latest sell-off in tech stocks.

Chinese stocks are a risky place to be in now. You don’t need to avoid them entirely, but brace yourself for much volatility ahead until Chinese regulators signal their crackdowns are over.

Global investment banks are rushing to divert Chinese stockmarket listings (also known as initial public offerings, or IPOs) away from the US to Hong Kong to prevent getting caught up in China’s clampdown on Chinese firms listing abroad, says the Financial Times.

Earlier this month Didi, a minicab app in the vein of Uber, was removed from domestic app stores just days after it raised more than $4.4bn in a blockbuster listing on the New York Stock Exchange.

So what is going on?

China’s tech war

The Didi debacle prompted the Cyberspace Administration of China (CAC) to launch a cybersecurity review into the firm. China alleged that the company – which has a market cap of around $40bn – illegally collects and uses its customers’ personal data.

Companies moving to Hong Kong further reflects how China’s aggressive policies are forcing them to reassess their plans. Around 20 companies were looking to raise approximately $2.4bn in New York this year from listings, but China’s tightening grip on tech firms has put this into doubt.

“We’re speaking to everyone about it. All the Chinese issuers planning New York IPOs are looking at whether they can pivot to Hong Kong,” a senior Hong-Kong banker told the FT.

This is not the first time China’s tech sector has come under the wrath of regulators. In May, Didi and several other companies were ordered by China’s anti-trust regulator to change their practices following allegations of unfair treatment of its drivers.

And before that, China tightened its grip on billionaire Jack Ma’s Alibaba-backed Ant last October. Regulators also imposed a $2.8bn fine this April, after an antitrust investigation concluded it had abused its market power.

So why Hong Kong?

China’s grip on tech firms has centred around data privacy. And given Hong Kong is closely controlled by China, companies ditching New York in favour of Hong Kong could make it easier for them to list. But is it a sensible move?

Chinese tech firms going public have mostly preferred listing in New York because of its convenience and greater ease of listing – due diligence levels and scrutiny is far greater in Hong Kong.

Another factor that makes New York more attractive is that bankers also get higher fees there, in the range of 5%-7%, compared to just 2% in Hong Kong.

It is not hard to see why Chinese regulators are fretting about US IPOs. Chinese companies raised $12.4bn in 34 IPOs in New York despite escalating tensions between the US and China. This helped raise US banks’ revenues, and has been particularly lucrative for the likes of Goldman Sachs and Morgan Stanley.

Relations between both of the world’s largest economies are at their worst point in post-war history over a host of issues including trade and Hong Kong’s financial status, and both remain at loggerheads on the origins of the Covid-19 outbreak.

Another key point worth noting is that Hong Kong boasts stricter rules, such as minimum profitability requirements.

While this means that “companies would struggle to sell shares in the territory”, the banker told the FT, it also potentially eradicates the cloud of uncertainty facing Chinese firms listing in the US and leaves less nasty surprises at the end.

So does that mean Chinese firms listing in Hong Kong are worth a buy?

New York or Hong Kong, one thing is clear: Chinese tech firms are coming under the same scrutiny that Western tech stocks face, with concerns about overly-influential companies run by highly visible billionaire CEOs at a time when wealth inequality is soaring.

Also, while Hong Kong is controlled by China, the territory has been subject to a lot of geopolitical uncertainty over the last two years including protests over a controversial extradition bill as well as the imposition of a Draconian security law which increases China’s power over the territory.

So Hong Kong may be seen as a less risky IPO haven compared to New York, but other challenges still persist.

That doesn’t mean you should entirely avoid Chinese stocks. Just be mindful that Chinese tech companies listing in Hong Kong doesn’t completely eliminate them from the risks facing tech stocks elsewhere.

Have Chinese shares turned a corner? The benchmark CSI 300 has tumbled by 8% since mid-February, but the index enjoyed its biggest weekly gain in three months last week, including a 3.2% leap on 25 May. That was its best one-day performance in almost a year.

The surge was partly driven by foreign cash, notes Jacky Wong in The Wall Street Journal. The Stock Connect platform, which allows foreign traders to buy and sell mainland shares, saw $7.1bn in net inflows over three days last week. That was the biggest three-day tally since the platform was launched in 2014.

Foreign inflows are also driving the yuan higher, says Karen Yeung for the South China Morning Post. The currency has hit a three-year high against the US dollar. It has also reached a five-year high against a basket of other major currencies.

Bargains in big tech?

China’s post-pandemic recovery has been rapid, enabling policymakers to remove fiscal and monetary support sooner than in many other economies, says Andrew Batson of Gavekal Research. That has been accompanied by a broader regulatory clampdown, including renewed efforts to temper a frothy housing market and fewer bailouts for state-owned enterprises.

There has also been a concerted push to curb the power of big tech platforms; last November regulators blocked the flotation of Alibaba-backed Ant Group.

Shares in big tech giants such as Alibaba and JD.com have slumped this year, says Yen Nee Lee for CNBC. The latter’s shares are down by more than 12%. Some think the sell-off has gone too far. While the regulatory clampdown brings near-term uncertainty, some of the big Chinese tech firms offer “decent value” after recent falls, says Howard Wang of JPMorgan Asset Management.

Wall Street banks are diving in, says the Financial Times. Goldman Sachs, JPMorgan and BlackRock have announced partnerships with local banks and other ventures as they seek to tap China’s vast savings market. Chinese households are conservative investors: about 60% of household wealth is thought to find its way into the housing market, with one-quarter held in cash. Beijing is keen to build a more sophisticated savings infrastructure as it prepares for “an impending demographic crisis”. Despite rising geopolitical tensions, “American finance has never been closer to Chinese wealth”.

Momentum could keep the stock rally running, says Wong. New curbs on cryptocurrencies and commodity speculation might drive more funds into stocks. But credit growth is slowing and the fastest phase of the economic recovery is now over. “Chinese stocks are due for a catch-up with other markets, but the wind may quickly turn chilly again.”

China crimps the commodities cycle

China may have “slammed the brakes” on the commodities supercycle, says Craig Mellow in Barron’s. On 23 May regulators vowed “zero tolerance” towards “excessive speculation” in the market. They are unhappy about reports of hoarding by commodities firms. That sent local metals prices plunging, with iron-ore contracts on the Dalian Commodity Exchange falling by 9.5%. Nevertheless, global copper prices are still up by 28% in 2021, while iron ore has gained more than 30%.

China has enormous leverage in the industrial metals market, says Mellow. The economy consumes 70% of worldwide iron ore and 58% of its copper; 60% of the domestic steel industry is also state-owned. Many investors think we are at the dawn of a new commodities supercycle, but “a few words from the Chinese government” are giving the bulls cause to doubt.

Chinese demand has been a crucial factor in previous raw-materials booms and in this one. Yet Goldman Sachs says the next leg of the rally will be driven by Western consumers. Economic reopening, stimulus and green investment are creating a demand spike for industrial metals in developed markets. Indeed, global copper prices increasingly respond to the latest Western manufacturing data, not that from China. The bank thinks that “key commodities such as oil, copper and soybeans” will remain in short supply in the second half of this year.

Shares in China’s top e-commerce firm Alibaba jumped by 10% after it received a $2.75bn fine for antitrust violations, says Callum Jones in The Times. Officials “could have fined the company more than twice that amount”. The antitrust probe concerned claims that the firm “abused its market dominance” by forcing merchants “to choose between doing business on its platforms and others”. It was launched just after Alibaba’s founder Jack Ma (pictured) vanished from public view for months last autumn after criticising the Chinese government.

Investors clearly think the fine is a price worth paying for Alibaba to put its legal woes behind it, especially since it is only “about 4% of domestic sales in 2019” says Lex in the Financial Times. But this may not be the end of the matter. Regulators have “voiced concerns” about Alibaba’s non-core businesses. What’s more, to remain in Beijing’s “good books”, Alibaba will have to spend more on “corporate good deeds... that support small businesses in rural regions”, lowering profits.

US giants such as Amazon should take note, says Gina Chon on Breakingviews. The fine shows that “it’s possible to define the market and single out data usage in ways that US regulators haven’t yet managed to do, but could”. Third-party merchants say Amazon “unfairly competes” against them when it “sells its own products using information gleaned from its platform”. Still, for now Amazon’s position seems secure, since US courts tend to be relaxed about such behaviour if it enhances “consumer welfare” by keeping prices low.

China's benchmark CSI 300 stockmarket index soared by 27% in 2020 thanks to the Covid-19-induced stimulus, but the rally peaked in February this year and the index has since tumbled by 13%. It has lost 4% since 1 January.

The main cause is tighter money, as Jacky Wong explains in The Wall Street Journal. The People’s Bank of China, the central bank, turned on the monetary taps last year in response to the virus. Yet with the recovery looking secure, it started to remove some of that liquidity from the financial system at the start of this year. “The spectre of bubbles past still haunt Chinese policy makers”: previous post-crisis stimulus efforts have saddled the financial system with a worrying debt burden. Regulators’ priority is curbing of speculation in property, but tighter credit brings “collateral damage” to stocks.

Big tech gets smaller

Chinese markets have also been affected by the ongoing global “rotation” away from highly-priced growth stocks (particularly technology companies) towards more cyclical sectors.

Shares in tech giants such as Alibaba, Baidu and JD.com were “hammered” last week after US regulators pressed forward with changes that could ultimately see the firms removed from US stock exchanges, reports Arjun Kharpal for CNBC. Many Chinese tech firms have dual listings in America in order to access a wider pool of investor capital.

Big Chinese tech firms are also under pressure in their home market from tighter regulation. Beijing appears to have concluded that the sector needs to be cut down to size to ensure social stability, says Eoin Treacy on Fuller Treacy Money. “Companies like Tencent and Alibaba” now face clear “limits” on how much further they can expand.

The market pullback hasn’t undermined an ongoing boom in initial public offerings (IPOs), notes Hudson Lockett in the Financial Times. The value of flotations in Hong Kong has hit $16.4bn so far this year, compared with just $1.8bn in the first three months of last year. Yet Chinese stocks are not the value play they once were. The CSI 300’s price/earnings ratio has risen from 12 to 19 over the past year.

Tighter money in China underlines a growing split between rich economies, where central banks plan to keep credit easy, and emerging markets, where central bankers are growing hawkish; Russia and Brazil both recently raised interest rates. China was “first in, first out” of the pandemic, Peiqian Liu of Natwest Markets told Sofia Horta e Costa and Richard Frost on Bloomberg.

Now, this “stockmarket rout” could provide another leading indicator for the rest of the world: “When central banks and governments start exiting pandemic-era stimulus” the results for investors are “not pretty”.

While US spending balloons, China has begun to tighten the fiscal taps, says The Economist. Prime Minister Li Keqiang has announced a lower fiscal deficit target for this year. Meanwhile, the central bank has begun to withdraw liquidity in a bid to cool speculation. Guo Shuqing, the country’s chief banking regulator, recently warned of bubbles in domestic property and global financial markets. Chinese investors have been put “on notice”.

The newly published five-year plan has not done away with the traditional growth targets, but they do appear to be “vaguer and more flexible than before”, says Andrew Batson of Gavekal Research. Instead, there is a pivot towards a “pledge to keep China’s debt-to-GDP ratio stable or declining”.

The renewed emphasis on debt levels has given investors pause for thought, say Joanne Chiu and Xie Yu for The Wall Street Journal. The CSI 300 stockmarket benchmark soared by 27% in 2020. Yet the index has slid by 10% from its latest peak. Still, this “slow bull market” may not be over yet, says Wendy Liu of UBS Global Research. Investors may just be catching their breath.

A key bullish factor is that Chinese mergers and acquisitions (M&A) activity has had its “busiest start to a year on record”, say Tabby Kinder and Thomas Hale in the Financial Times.

The total value of domestic dealmaking amounts to $77.5bn so far in 2021. Mainland Chinese businesses used to go on acquisition sprees abroad; but now Beijing wants to develop more domestic, consumer-led industries, while geopolitics has made overseas acquisitions more difficult in recent years, says David Brown of PwC. “That has redirected a lot of capital that would previously have gone outside the country back into domestic acquisitions”.

Chinese electric-vehicle (EV) company Nio, listed in New York, has become “one of the most popularly traded stocks in Britain” because many see it as “the next Tesla” says The Times. The stock has risen 28-fold from $2.11 in March to about $60 today. Nio’s market value eclipses that of both General Motors and Ford. Nio is also endorsed by many “admired and successful technology investors” who argue that it is “probably the clear leader” among Chinese electric-car companies.

Nio’s surge marks a sharp change in fortune from last year, when it “appeared to be teetering on the edge of insolvency”, says Alison Tudor-Ackroyd in the South China Morning Post. Not only had Covid-19 “crimped” sales, but the company was also reeling from the Chinese government’s cuts in subsidies as well as the prospect of stronger competition from Tesla in its home market. However, Beijing then reversed course, with a state-controlled company making an emergency injection of cash into the company, enabling Nio to boost production. It recently unveiled a new model that claims to “go as far as 1,000 kilometres (621 miles) on a single charge”.

A rich valuation

Nio’s shares could go even higher, says Trefis Team on Forbes. Sales are “poised to double to about $5bn in 2021”. Nio will benefit from the fact that China “has set a target that 25% of car sales by 2025 must be new-energy vehicles”. It is also developing a modular battery system that will allow users to swap batteries quickly, making it easier to travel long distances, and promising an improved self-driving system. Still, its valuation looks “rich” and it is not clear that it has done enough to build “a sustainable competitive advantage”.

The frenzy surrounding Nio is certainly helping it “suck up capital”, with the company announcing last week that it is issuing $1.3bn in convertible bonds, says Anjani Trivedi on Bloomberg. Still, investors need to be cautious, as the “fandom” that these shares have been enjoying is unlikely to last if they can’t deliver tangible results. Note that Nio “hasn’t been profitable since inception”. It recently admitted that “it may have to scale back operations if it can’t move into the black”. The big challenge is “less about getting people revved up for electric cars” and “more in making good, affordable vehicles – at scale”.

The Chinese EV sector looks due for a shakeout, says Christian Shepherd and Thomas Hale in the Financial Times. Around $60bn in government subsidies for EVs between 2009 and 2017 prompted “hundreds of new companies” to spring up in China. But many pocketed these sweeteners “without ever manufacturing a car”. New models by firms such as Nio and Xpeng have “invigorated” the market, but the Chinese government is so anxious about fraud and waste that Beijing is ordering local governments “to investigate land use, investment and progress of EV projects initiated since 2015”.

2020 has been a landmark year for Chinese markets, say Hudson Lockett and Thomas Hale in the Financial Times. Foreign investors have bought more than ¥1trn (£113.5bn) of local assets. Onshore bonds have been attracting particular attention, and little wonder: the US ten-year Treasury bond yields 0.9%, compared to 3.3% for the Chinese equivalent. There were ¥900bn (£102bn) in net foreign inflows into bonds during the year through to the end of November. Local stocks also took in ¥170bn (£19bn) from overseas buyers. The CSI 300 stock market benchmark is up more than 19% this year.

The world’s sudden need for masks and gel, coupled with demand from locked-down workers for IT equipment, has played to the country’s “manufacturing strengths”: medical equipment exports rose 42.5% on a year before during the first 11 months. Electronics exports rose 25% last month on the year.

These new “global consumption patterns” should unwind next year as a vaccine is rolled out, Julian Evans-Pritchard of Capital Economics told the South China Morning Post. Yet lower exports will be offset by strengthening domestic activity. The Chinese economy has continued to grow “across all fronts”: retail sales rose 5% on the year in November, while industrial production gained 7%.

China is expected to be the only G20 nation to grow this year. By the end of 2021 the economy could be the same size as it would have been if the pandemic had never happened, says Simon Cox in The Economist. Policymakers have resorted to a familiar infrastructure-first stimulus playbook this year, leaving efforts to bring down debt levels to one side. 2021 will thus see the country confronting the same problem it had before Covid-19: how do you “deleverage the economy without killing growth”?

It is difficult to understand what Jack Ma was hoping to achieve when he spoke at a high-level financial summit in Shanghai on 24 October. The Alibaba founder was just about to preside over the initial public offering (IPO) of Ant, the giant payments, investing, lending and insurance platform that has become the world’s most valuable financial-technology firm. Yet Ma – who has long had a fraught relationship with China’s financial establishment – decided that this was a good time to launch an open attack, suggesting that old-fashioned regulators are stifling innovation and bluntly accusing banks of a “pawnshop mentality” that can’t meet the credit needs of today’s economy. Neither is capable of delivering the financial system that modern China needs – unlike Ant, he implied.

Whether he’s right or wrong – there was plenty of self-interest at play – it’s a well-argued speech that makes valid points about China’s sclerotic banks. But the consequences were swift. Ma and top executives were summoned to meetings with regulators. Officials published a draft of tougher rules for online microfinance businesses, such as Ant’s lending operation arm. And perhaps most significantly, Ant’s IPO, which was set to raise a record $35bn (£26bn) in a dual listing in Hong Kong and Shanghai, was put on hold. Since this float was set to be a matter of no small prestige for China, it seems certain that Xi Jinping, the Chinese president, will have signed off on the decision, as The Wall Street Journal subsequently reported.

Top Chinese executives are both politically astute and politically vulnerable. Ma himself stood down from the board of Alibaba in 2019, for reasons that are unclear; there has been speculation that he was forced out by a government that is concerned about any individuals whose profile and influence might pose a threat to its authority. That makes it doubly baffling that he would make such a provocative speech – remarks that he was urged to tone down by several people close to him, according to Reuters. One view is that it was simply a moment of hubris; another is that Ma already knew that tighter regulation was on the way and this was a last-gasp effort to set the terms of the debate and head some of it off. Either way, his gamble appears to have failed.

A sector under scrutiny

While Ma and Ant have made all the headlines recently, they aren’t the only part of the tech industry coming under scrutiny. Last week, competition authorities proposed new rules in areas such as below-cost pricing and exclusivity agreements that might curb the ability of Alibaba and other heavyweights to squash smaller rivals before they can pose a threat.

Meanwhile, Caixin, a leading financial magazine, ran a major story claiming that law enforcement is investigating search portals, social media platforms, digital payments systems and ecommerce sites run by the big tech firms for allowing illegal gambling sites to attract users and to disguise betting transactions as online shopping. Caixin has a record of knowing what targets are in the sights of the authorities; the high-profile crackdown on insurance group Anbang in 2017 and the imprisonment of its founder on charges of embezzlement and fraud were preceded by a series of critical articles in the magazine. So the timing of this story may be significant.

Other than requirements to censor content and the occasional brief regulatory storm (such as accusations in 2018 that Tencent was not doing enough to prevent children being addicted to online games), China’s tech giants have been given considerable latitude to operate in an economy that is otherwise highly regulated in many sectors. That’s one reason why they have grown, expanded and innovated in a way that makes Western tech giants look comparatively stodgy. The picture of a sector being told to fall into line – or else – is becoming increasingly clear.

Trebling down on state control

This crackdown – if that’s what it proves to be – is the latest of three major developments in China during 2020, all of which need to be viewed together when thinking about what the next few years might bring. The first, of course, was Hong Kong. In dealing with the escalating crisis there, China faced a choice between coercion and persuasion. The most likely path seemed to be a combination of the two: it would be difficult for the government to give way on many of the political issues that were the direct pretext for the protests, but policymakers could readily make concessions on some of the economic grievances that underpin the unrest (eg, the high cost of housing and other basic services that result from well-connected tycoons dominating these sectors).

This was certainly my expectation when I wrote about the outlook for China in MoneyWeek last year. The reality so far has been entirely different: all stick, no carrot. Beijing has made zero effort to buy off protestors with populist economic policies, but has doubled down on security measures. It has imposed new laws on Hong Kong that criminalise dissent and allow mainland security personnel to operate in the region. Leading figures in the anti-government protests are being prosecuted and opposition politicians expelled from the legislature. While the legal and political system in Hong Kong technically remains separate from the rest of China, any meaningful autonomy has been stripped away. The belief that “one country, two systems” would continue to operate in a predictable and reliable way until 2047 has completely ceased to exist.

The second significant event was Covid-19. When the disease first emerged, it seemed like the government’s response – including early efforts to cover it up – might prove a significant blow to the Chinese Communist Party (CCP). The CCP retains power as a one-party state not purely because it’s good at suppressing dissent and discussion of any alternative political systems – as many people tend to assume – but because the higher tiers of the government are widely trusted to deliver economic development, public safety and international clout for China (even if local-level officials are often mistrusted). A pandemic that swept across China and caused vast amounts of death could well have shaken faith in the government’s ability and undermined its legitimacy.

Yet if anything, the CCP has emerged with its reputation enhanced and its authoritarian approach to civil society and personal freedom validated. After almost a year of this crisis, China is still functioning more normally than most of the rest of the world. Even if one assumes that there could still be wider outbreaks of Covid-19 than are acknowledged, there’s no doubt that most of the economy and society are now open.

Meanwhile, the rest of the world has rushed to embrace indiscriminate confinement, widespread surveillance, travel restrictions, mass testing, government and media information campaigns so unbalanced that they amount to propaganda, severe criminal penalties on what were once held to be inalienable basic freedoms – exactly the kind of measures that were initially condemned in China. And despite abandoning their principles, most countries have suffered higher infection and death rates combined with worse economic and social outcomes. The idea that Western democracy offers a better model of governance than the CCP now looks laughable within China and perhaps increasingly elsewhere.

A 21st-century Cold War

Put all this together and you can see that China is confidently continuing down a path of greater state control and narrower scope for disagreement. Of course, this process began quite a while ago. Restrictions on journalism and online freedom of speech, which had been unevenly loosening, began to tighten again early in the past decade. Quite quickly after becoming president in 2013, Xi consolidated power around himself, began to build a cult of personality and abolished term limits that would have forced him to stand down in 2023 – all of which was a retreat from the way that the CCP had steadily tried to embed a collective system of leadership after the death of Mao Zedong. The expectation that prominent individuals and companies must serve the interests of the nation rather than just acquiring wealth or influence for themselves has become increasingly firm. But the events of 2020 may be a turning point.

That’s partly because China’s relations with the West continue to deteriorate, for reasons that can be shared among both sides. Things may improve a bit when Donald Trump is no longer stirring the pot, but a good deal of damage has been done. China and the West will remain tightly connected by trade, but the schism between them in certain areas will continue to grow. Technology is on the frontline of what might turn into a 21st-century Cold War. Western governments are increasingly vexed about the security implications of Chinese firms having access to their infrastructure and data, and about whether China should have access to Western research and technology in areas that are likely to play a key role in future rivalry, such as artificial intelligence (AI).

This may not affect Alibaba and its peers directly, because their area of tech is already divided. Amazon, Google and Facebook operate almost everywhere except in China, while their Chinese equivalents (see below) do little outside their borders. Trump’s attacks on social-media video platform TikTok (owned by China’s ByteDance) in August were an exception; it’s one of few Chinese-owned services with widespread international use. WeChat, which Trump also tried to ban, is used mostly by the Chinese diaspora, while Alibaba’s services are used by international buyers but only to connect with Chinese sellers.

However, this climate will almost certainly hinder their ability to expand their services abroad over time, as some would clearly like to do (their best remaining option is likely to be southeast Asia, where several already have affiliates and investments). So their future is mostly dependent on the opportunities that China offers. These are currently huge, but tough or capricious regulation might change that. Rules to create more competition might make them slower-growing or less profitable. Restrictions in areas such as financial services – which have offered some of the best opportunities – could make these less attractive.

Putting the state first

Ultimately, if the government believes that they are too powerful or too wide-reaching, they could be broken up or even have some parts of their business taken over by the state. The latter may be a worst-case scenario, but it’s not impossible. No legal system can provide protection against government seizure, but the variable interest entity (VIE) structure used by Chinese tech firms listed abroad is unnerving. Foreigners can’t own assets like these in China, so the listed company is set up to entitle them to the profits without owning the assets. The legal status and enforceability of VIEs are a grey area, to say the least, which Ma exploited when he spun off Alipay – the business that became Ant – from Alibaba in 2011, without the approval of Softbank and Yahoo, who co-owned it.

It’s also worth bearing in mind that while China’s tech giants have been very successful – and the pandemic has given them a further boost, just as it has for tech firms elsewhere in the world – they don’t necessarily represent the kind of success that China now wants most. If the focus is on outcompeting the West in AI or semiconductors, the government may want resources directed there. That could mean that firms are at some point encouraged to fund research in this area whether it makes business sense or not.

There are no certainties here – both negative and positive. For that reason, it seems odd that investors are willing to pay 50 times earnings for Alibaba, 40 for Tencent or 150 for JD.com, yet wonder whether cheaper Western peers are pricing in regulatory risks. Since Alibaba is 20% of the MSCI China index and Tencent is 15%, any fund that tracks the index closely is taking a big bet. If you’re nervous about this, check your exposure (these firms are often classed as consumer not tech, so don’t just look at the sector weightings). Personally I’d prefer lower exposure, so if I were picking a fund, I would favour something like FSSA China Growth. If I were buying directly at the moment (which I’m not – I’m hoping for better opportunities), I’d opt for Tencent ahead of the rest.

Today’s top Chinese tech firms

Alibaba (NYSE: BABA) is often viewed as the Chinese equivalent of eBay, although even its traditional services are much broader: it operates multiple business-to-business, business-to-consumer and consumer-to-consumer platforms including the eponymous Alibaba, AliExpress and Taobao.

A sprawling series of other business and investments include logistics, online travel booking, ticket selling and online streaming for events, cloud computing and AI, health and even investments in physical supermarkets and the South China Morning Post newspaper (making it more like Amazon and Alphabet in its enthusiasm for entering new areas). Alibaba also controls Lazada, an Amazon-like ecommerce platform in southeast Asia.

The Alipay payments business is closely connected with Alibaba, but operated by Ant, a separate business that also offers loans, investment products, insurance and other financial services. This group (and in particularly its lending arm) were behind the recent storm, not Alibaba itself.

Tencent (Hong Kong: 700) began as a provider of online games, but its QQ and WeChat services made it ubiquitous. These are often compared to Facebook Messenger and WhatsApp, but Tencent’s services are used for online orders and payments to a much greater extent. The firm is also involving in producing and distributing TV, film, music and other entertainment content, ecommerce, health and other services, as well as investing in AI and cloud technology. It holds a stake in Sea (NYSE: SEA), a firm in southeast Asia that also began in online games and is following a similar strategy.

JD.com (NYSE: JD) is an Amazon-like ecommerce business, investing heavily in logistics including drones and robotics, as well as the usual themes of AI and cloud computing. It has a financial technology division – JD Digits, whose IPO may also be delayed by the crackdown – which provides online lending, but is focusing more on providing technology to financial institutions. It’s also aiming to spin off its online healthcare and pharmacy arm to take advantage of soaring demand for these stocks.

Baidu (NYSE: BIDU) is a search engine that rolled out Google’s business model successfully in China and hasn’t really innovated much over the years. There’s a good reason why it trades on a lower valuation than its peers (17 times earnings): while it is finally investing in new services and technology, it is at risk of getting left behind.

All four of these firms are well-established and generate plenty of cash. The other two firms you’ll see in many China funds are at a much earlier stage. Meituan-Dianping (Hong Kong: 3690) can’t be compared to a single Western peer: it combines services including group discounts, food delivery, ticket and travel booking, business reviews, bike rental and car-hailing. It’s profitable but a p/e of 450 is pricing in a lot of growth.

Pinduoduo (NYSE: PDD) lets buyers pool together to get discounts, adding social media on top of a Groupon-style business. This model is unproven: it is still making losses and offering heavy subsidies to attract users.

The last two big names are Didi Chuxing (essentially China’s Uber) and ByteDance (which owns TikTok). Both are privately held.

Digital-payments giant Ant Group is poised for the “largest stockmarket flotation of all time” next week, says James Dean in The Times. It is set to raise “at least $34.4bn” from a dual listing on the Hong Kong and Shanghai stock exchanges. This would not only be more than the $29.4bn raised by Saudi Aramco last December, but could also see the firm valued at $313bn, around the same as JP Morgan. The flotation will also turn Alibaba founder Jack Ma into the world’s 11th richest person, with a fortune of $72bn, thanks to his controlling interest of 8.8% in Ant.

The “frenzy of interest” has been so great that the book for the Hong Kong listing was oversubscribed an hour after the launch on Monday, says Hannah Boland in The Daily Telegraph. Ant’s impending listing has even caused the Hang Seng index to fall based on fears of a liquidity squeeze as investors rush to sell existing stocks in order to free up cash to buy its shares. Enthusiasm has been further stoked by the fact that Ant Group’s reported profits jumped by more than 70% year-on-year in the third quarter.

A bet on China’s middle class

Investors pinning their hopes on Ant Group “might not be entirely crazy”, says The Wall Street Journal. After all, “hundreds of millions” of Chinese consumers now use Ant to access “payment services, banking, loans, insurance and the like”. This is a bet that China’s middle class will continue its “inexorable” expansion. Jack Ma has a long record of understanding consumers’ needs; witness the success of his online-shopping platforms. What’s more, Chinese protectionism means that foreign payment-processing firms such as Visa and Mastercard have only recently been allowed to offer services to Chinese people in China.

Simply fending off foreign competitors may not be enough, says Robyn Mak on Breakingviews. If Ant Group wants to justify its valuation of 24 times 2022 earnings, it will need to expand further. This may prove difficult as it already accounts for a quarter of Chinese financial transactions related to online credit, insurance and wealth management. And while the company has benefited from implicit support from Beijing, this can change – as it found out when Chinese regulators imposed new rules on Ant’s “once-booming” money-market fund, drastically slowing its rate of growth.

It’s not only Chinese regulators that Ant Group’s investors should be worried about, says Lex in the Financial Times. Other countries, including India, are cracking down on Chinese apps, hampering overseas growth. Ant Group’s “tight ownership structure” and “complex” balance sheets, especially its many long-term investments in other companies, are other potential risks. Up until now this “hinterland” has helped Ant Group, with the disposal of the local services group Koubei preventing it from falling “deeply into the red” two years ago. However, there is no guarantee that its other investments will be so successful.

China was the first country into the Covid-19 crisis and is now the “first out”, writes Larry Elliott in The Guardian. The world’s second-biggest economy contracted by an annual 6.8% in the first three months of the year, but has since staged a V-shaped comeback. Official statistics show that GDP increased by 4.9% on the year in the third quarter. The International Monetary Fund (IMF) thinks China will grow by 1.9% in 2020, making it the only major economy set to expand.

The debt question

Industry continues to lead the recovery, says Bloomberg. Consumption for the first three quarters is still 7% down on the same period last year and “tourism, education and travel” lag behind other sectors. Yet the latest data shows that shoppers are starting to close that gap, with retail sales growth accelerating in September. The recent Golden Week holiday encouraged many people “to open their wallets again”.

Economists take China’s official growth statistics with a pinch of salt, says The Economist. One camp argues that while the numbers are “overly smooth” they paint a generally accurate picture of what is going on. Sceptics argue that they are more fundamentally misleading. Yet whomever you ask, everyone agrees that the current rebound is real: to see that you only need look at China’s “bustling shopping malls… and its mobbed tourist sites”.

Household borrowing growth has been muted in most advanced economies this year, but not in China, says Mike Bird in The Wall Street Journal. IMF data shows that the country’s household debt to GDP ratio is 31.6% higher than it was a decade ago, by far the biggest jump among the world’s top ten economies. Much of that borrowing goes towards property purchases, sustaining a “nexus between banks, home buyers and real-estate developers” that helps keep activity ticking over. Yet “leaning on households again” will only deepen the economy’s “financial vulnerabilities”.

A rally with legs

China’s CSI 300 index is up more than 15% so far this year, comfortably beating the 5% gain on the US S&P 500. With the virus under control and the economy bouncing sharply it is little surprise that Chinese shares are soaring, says Fidelity’s Tom Stevenson in The Daily Telegraph. The total value of listed Chinese equities recently surpassed $10trn for the first time. Risks include a frothy property sector and a probable resumption in trade spats whoever wins the US election. But a “well-balanced portfolio” can hardly ignore the country.

As elsewhere, China’s rally has been led by a “narrow wedge of tech powerhouses” while value shares have lagged, says Craig Mellow in Barron’s. Bull runs in 2015 and 2017 “ended badly”, but the market is no longer the Wild West. There are stricter rules on leverage and flighty retail investors are increasingly being replaced by institutional investors, who account for “70% of traded equities”. This “rally could have legs”. (Listen to our podcast with Pictet’s Shaniel Ramjee at moneyweek.com/podcast for more on China).

Almost half a billion people are going on holiday, says Bloomberg News. China’s October Golden Week saw 425 million people travelling during the first four days alone, according to official figures. That is almost 80% of last year’s level. China has gone six weeks without a reported Covid-19 case and the holiday is a key test of what life will look like beyond the pandemic.

China’s economy could do with a boost from consumers, Françoise Huang of Euler Hermes told the Nikkei Asian Review. Its strong recovery in the second and third quarters has been led by construction and infrastructure, with consumption “somewhat sluggish”. The OECD forecasts that China will grow 1.8% for 2020 as a whole, the only G-20 nation to expand this year.

Economists polled by Nikkei agreed that if Trump is re-elected then US-China trade ties will worsen, but were divided on the likely impact of a Biden presidency. Some argue that Biden would cut tariffs and ease sanctions on Chinese technology firms, while others point to a growing bipartisan consensus in Washington that favours a tougher line on China.

China’s strong economic recovery has propelled local stockmarkets higher, notes Chong Koh Ping in The Wall Street Journal. The CSI 300 index is up 12% for the year-to-date, comfortably surpassing the S&P 500’s 3.6% gain. Shares in consumer-facing businesses such as tourism, beverages and carmakers have rallied as the pandemic has been brought under control.

Investors scared of the turbulence of the US election are betting that Chinese onshore markets will prove “somewhat insulated” from broader geopolitics in the coming months. China’s yuan rose by 4% against the dollar in the third quarter of 2020, its best quarter since 2008, as foreign money poured in. Expect “more gains” to come in local markets.

China’s recovery is gathering strength, say Finbarr Bermingham and Amanda Lee in the South China Morning Post. Industrial production continues to lead the way, rising by 5.6% in August on a year before. There are also signs of a consumer rebound: retail sales advanced by 0.5% on the year in August, the first growth recorded this year.

China is the only big economy the International Monetary Fund thinks will expand this year. The encouraging economic backdrop means the bulls are out in force. The benchmark CSI 300 stock market index has gained 12% so far this year and is up by 32% since 23 March.

The rally has brought plenty of signs of excess. Shares on the Star market, a technology-focused equivalent to America’s Nasdaq, have been trading at “huge premiums” to “near-identical” stocks listed in Hong Kong, says Xie Yu in The Wall Street Journal. The fact that local investors are willing to pay up to five times as much as offshore buyers for the same assets suggests a speculative frenzy. However, regulators intervened to cool excesses over the summer, with the CSI 300 now off 3% from a mid-July high. The Star market froth makes more sense than you think, says Shuli Ren on Bloomberg. Too often foreign investors think China is “just another growing emerging market” with a rising middle class.

That prompts them to buy into consumer stocks such as Luckin Coffee (which later turned out to be a fraud). Locals, by contrast, know that nothing is as solid as a sector that has almost unconditional government backing: pricey technology firms. Chinese markets are driven by retail investors and can provide a wild ride. But authorities tend to step in if they fall too far. In a lousy year for the global economy, China’s markets are a rare bright spot.

I wrote about the new enthusiasm for Chinese equities among the world’s equity strategists in the FT earlier this week. There are all sorts of drivers behind the shift – that the market is not totally correlated with developed markets (everyone needs diversification); that China is opening its capital markets to the world; that as, Gavekal put it, China is “the only major economy in the world today where local policy makers are not actively pursuing the euthanasia of the rentier” (ie, real bond yields are actually positive).

But one of the more interesting points on this market was actually made last year – pre-pandemic – by Gavin Ralston and Krisjan Mee of Schroders. It is partly thanks to the participation of enthusiastic, but not fundamentally driven retail investors (in 2018, 86% of A-share trading was retail).

The Chinese A-shares market is wonderfully inefficient – something that makes it “fertile ground for active managers”. Over the five years to March 2019, when this paper was written, the median active manager in China A shares was able to earn an annualised return over the market of 6.3% after fees. This is, say Ralston and Mee, “an exceptional figure by global standards”. Elsewhere median excess returns have been either close to zero, or in some cases (the US being the standout example) negative (after fees the average manager does worse than the index).

Also of interest are the figures for passive funds. Most developed market exchange-traded funds (ETFs) tend to underperform the indices they track by their management fee – which makes sense. Not so for China A shares. The largest A shares-tracking ETF has regularly underperformed the index by significantly more than is implied by its expense ratio.

We have written a lot here over the years about whether one should invest passively or actively. We’ve made it clear along the way that the answer is partially market dependent. You can’t expect an active manager to have much luck outperforming in the global large-cap space. You can expect him to if he is investing across all market capitalisations in Japan or India. And it seems you most certainly can if he is investing in China A shares. One reason, then, to hold a stand alone allocation to Chinese equities (the political nose-holding required aside) is that China is one of the few markets in which good investors can have a hope of making good returns “even if the market as a whole does not deliver”.