China may be cheap, but is it cheap enough to make investing there worth it?

Xi Jinping wants to provide a “safe spiritual home” for China's population

(Image credit: © Lintao Zhang/Getty Images)

published 7 September 2021

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.

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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.

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.

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.

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.

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Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.