China is a country that 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.
The story of China’s rise to world superpower is fairly well known. Former chairman Deng Xiaoping launched an Open Door Policy in 1978, opening China’s economy to the world. Foreign investment then began to pour in as China industrialised and earned a reputation as the world’s factory.
The scale of the transformation was significant. Chinese exports accounted for less than 1% of world trade in 1978, but today China is the largest exporter in the world.
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Since the late 1970s, 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 an $18 trillion economy, second only to the US in terms of GDP.
China has also undergone a dramatic demographic shift in recent decades. The country has generated significant wealth in many areas and has a large and growing middle class. This has driven demand in areas like luxury goods and education – although there have been challenges with consumer demand more recently.
The country has also become a scientific and tech superpower. Its heavy investment in research and development means there is a huge amount of innovation happening in Chinese companies. Electric vehicles are just one example. China is a leader in this space and now sells more electric cars than conventional ones within its territory.
When you look back at this recent history, investing in the country could sound like a no-brainer. But significant challenges have emerged in the economy over the past three years, prompting investors to pull record amounts of money out of China in recent quarters.
Against this backdrop, we take a closer look at the region. What headwinds are markets navigating and is there still a long-term case for investing in China?
Challenges in the Chinese economy
Chinese stock markets have experienced strong headwinds in recent years thanks to problems in the broader economy. The country is currently in the midst of a prolonged crisis in the property sector, which began with the default of Evergrande Group in 2021. Consumer confidence is weak as a result, and this is having a knock-on effect on spending.
On top of this, local governments are heavily indebted, youth unemployment is high, and the country is grappling with an ageing population. There are also very real concerns that China might not meet its 5% growth target for this year.
Of course, in the global context, 5% growth doesn’t sound particularly bad. The International Monetary Fund (IMF) expects the global economy to grow at a rate of 3.2% in 2024 and 3.3% in 2025, putting China’s 5% target comfortably above this level. China’s GDP is expected to slow further going forward, though. The IMF expects it to fall to 3.3% by 2029 because of “headwinds from ageing and slowing productivity growth”.
Despite this, developments in recent weeks have sparked some optimism after Chinese leadership announced a string of stimulus measures intended to support the economy. This has led to a sharp rally in stock markets.
Recent stimulus measures and Chinese stock market rally
On 24 September, the People’s Bank of China announced rate cuts and other monetary policy tools to support the Chinese economy and markets. This was followed shortly after (26 September) by a Politburo meeting where fiscal stimulus was also promised. Chinese leaders said they would carry out “necessary fiscal spending” to meet this year’s 5% growth target.
As recently as this Saturday, 12 October, China added that it would “significantly increase” debt to boost investment in the economy. However, so far, no numbers have been provided.
Stock markets responded positively to the announcements overall, albeit with significant volatility as investors await further details on the scale of the full package. The Shanghai Composite Index (mainland China) and the Hang Seng Index (Hong Kong) have surged 17% and 14% respectively over the past month, bringing their year-to-date returns to 7% and 20% respectively. The rally has fizzled slightly in recent days.
“At this stage, we think it is positive to see the Chinese leadership’s rising commitment to deal with deflation risks and to achieve stabilisation in the property market. These are key aspects to any recovery in consumer confidence and demand,” says Dale Nicholls, portfolio manager of the Fidelity China Special Situations investment trust.
Nicholls adds that he will be “looking for more details coming out of the National People’s Congress (NPC) Standing Committee meeting and the Central Economic Work Conference later this year”. The hope is that any support policies can “help drive a turn in economic fundamentals, leading to an improved earnings outlook,” he says.
Should you invest in China?
After a challenging period for the economy, Chinese stocks were looking unloved and undervalued before the recent rally.
This is a topic Max King explored in a recent column for MoneyWeek, pointing out that most fund managers investing in Asia are “cautious” on China, including the Schroder Asian Total Return investment trust. The portfolio is currently “significantly underweight” in its allocation to China compared to the benchmark, King points out. But does China still look undervalued after the developments in recent weeks?
“While less extreme after the recent move, valuations in China remain compelling relative to history and global peers, and I believe there is still ample room for valuation multiples to expand further,” Nicholls says.
“While the earnings outlook for China in aggregate is not bad in a global context, and [there are] strong results in areas like technology, the general trend of earnings revisions has been downward,” he adds. If recent stimulus measures can help turn this around, Nicholls says it could result in a “virtuous circle”, driving a “sustained improvement in market sentiment and further re-rating”.
But it’s not just valuations and the latest stimulus measures that investors should be focusing on when weighing up the merits of an allocation to China. There are also a range of long-term structural drivers to consider.
Nicholls tells MoneyWeek: “Despite the weakness that we’re seeing in consumption [right now], I don’t think there’s any question if we’re looking out over the next 10 or 20 years. The proportion of consumption in the overall economy will grow.”
He adds that services are likely to grow faster than goods over time – something investors are already seeing in the current period in sectors like travel and education. Areas like the insurance sector could also present opportunities in the mid-term, he says, with people looking for more protection over time.
On top of this, there is a huge amount of research and development taking place in China. Companies who are investing in innovation in the right places could see growth as a result.
In many areas, Nicholls says there is “significant room to take share in sectors that are still dominated by foreign players in China”. Electric vehicles could be one such example. Tesla is a stock we have covered extensively at MoneyWeek, but the US company has faced challenges this year, partly caused by weakening demand in China as consumers opt for domestic EVs instead.
Of course, headwinds remain in spite of these long-term growth trends. We don’t yet know how successful stimulus measures will be and a potential Trump presidency could add further complexity to the picture. Despite this, there are still some exciting areas of opportunity for investors who know where to look. Active managers hope they will be able to capitalise on these areas of opportunity by separating the winners from the losers.
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