Is China investable?

China as an investment opportunity would seem a no-brainer. It’s the second-largest economy in the world. It is the world’s largest exporter of manufactured goods, one of the largest importers of commodities and the third-largest trading partner with the U.S., after Canada and Mexico. Yet after a rash of jarring actions over the last two years, investors may be growing wary of the risks, and rightly so. Today’s China is far different than the one a decade ago, when financial markets focused on its growing global dominance in key industries and trade.

Then came dustups with the Trump administration, 2020’s abrupt scuttling of financial giant ANT Group’s IPO (and the relegation of founder, Jack Ma), followed by crackdowns on Hong Kong and China’s massive online tutoring and test prep industry. There were a renewed “Common Prosperity” initiative that reintroduced more centralized control of private enterprises, Covid zero policies that shut down entire cities and regions and cut China off from the world, and October’s 20th National Party Congress, where investors hoping for signs that economic growth and stability would be prioritized got more uncertainty instead. All of this has driven up the risk premium of investing in China and driven down its weightings in the MSCI Emerging Markets Index, from 41% to 27% over the past two years.

Of course, there always are risks associated with investing overseas and particularly in Communist countries. The question is, are you getting paid for the risks? Below are three factors we think investors should weigh as they seek to answer that question:

• Xi Jinping Elected to an unprecedented third term as last month’s National Congress, Xi has a clear runway to stay in power through 2035 or longer. The Chinese Communist Party’s Politburo is packed with loyalists, and history tells us a centralized government with no opportunity for alternative voices to be heard is not a good thing. Will ideology, nationalism and income equality take a front seat to economic growth and stability? Short term, we don’t think so. China’s economy is suffering and even its leaders recognize it needs to ramp up growth. But longer term, it seems clear ideology will play a bigger, if not dominant, role in China’s behavior. How that impacts growth, entrepreneurism and corporate earnings, it’s just too early to tell.
• Taiwan Despite Xi’s opening speech at the National Congress, where he said, “We are closer, more confident and more capable than ever of reaching the goal of rejuvenating the Chinese nation,” we don’t expect an invasion of Taiwan over the next few years. China’s military just isn’t prepared or equipped for a large-scale assault of a mountainous island. Instead, we think it will be patient and pursue a methodical approach toward the reunification of Taiwan. Think of how Hong Kong was reunified with China (although it did turn ugly in the past few years as Xi and party leaders imposed stronger controls decades before it was fully expected). Also, China’s patience could be tested if it thinks Western governments are exerting too much influence in Taiwan.
• Investment opportunities China remains a market with dynamic, fast-growing companies that are leaders in manufacturing, green technology and suppliers of valuable commodities. Near term, when Covid restrictions are lifted—and there growing signs this could come soon—a strong economic expansion seems certain. This also could potentially unleash a market friendly global flood of dollars that have been built up in China for more than two years as it ran a massive trade surplus with the U.S. but was unable to recycle those dollars because it was cut off due to Covid restrictions. All that said, longer-term structural issues point to slower growth in China. Headwinds range from political uncertainty, concentration of power and aging demographics to trade wars with the U.S. (the latest over a U.S. chip embargo) and bloated property markets. Simply put, the days of 6-8% GDP growth have passed, making China a less attractive place to invest solely because potential returns aren’t likely to compensate you for the risks.

Bottom line: investing in China always has been different

Looking at China through a Western lens is unavoidable. Having just seen one dictator acting irrationally, invading Ukraine, killing thousands of civilians and generating hundreds of billions of dollars of global losses, investors should be skeptical of Xi’s consolidation of power. Evolving geopolitical alliances, reshuffling supply chains, fragmenting technology platforms and rising trade barriers—all contribute to increased uncertainty. But as always, with uncertainty, also comes opportunity. We think China remains an investable market. The key is to approach it with caution, knowledge and perspective.