This week we want to briefly discuss the Chinese stock market. Since the beginning of 2021, their stock market has declined by almost 50%.
While China has the second largest economy in the world, their stock market now accounts for just 2.4% of the global stock market capitalization. Switzerland has a similar stock market capitalization but China’s economy is 22x larger than that of the Swiss.
Just to give you some context for just how beaten up the Chinese stock market has gotten—the entire Chinese stock market is now worth less than the three largest market cap US stocks.
So what has driven this enormous collapse in value?
From our research it appears that foreign investors have fled the Chinese stock market based on the assumption that western economies would delink from the Chinese manufacturing base and restructure their supply chains. These investors believed that this shift in the west would reduce profits and increase instability in China.
But did this happen?
Not according to Louis Gave, CEO at Gevekal Research. He said,
“Yes, the Western world is trying to reduce its dependency on supply chains, but meanwhile, China’s footprint across emerging markets is growing by leaps and bounds. And so, when you look at China’s trade surplus, that has gone from $30 billion to $70 billion over the past five years.
Five years ago, the Western world decides—basically the US and then others tag along—that China’s a bad actor, that we need to freeze them out, we need to block them from global supply chains. We fast-forward to today, and the trade surplus is up 2.5X.
So arguably, you could say, ‘Okay, well, that’s been a failure,’ but that whole growth has come from trade with emerging markets. If you go back to just five years ago, China’s exports to Southeast Asia, to ASEAN countries—so, the Indonesias, the Philippines, the Malaysias of this world, the ASEAN countries—was about 60% of China’s trade to the US.
Now, in the past five years, China’s trade to the US has basically flatlined. Meanwhile, China’s trade to the ASEAN has more than doubled. So that today, China’s trade into Southeast Asia is 120% of China’s trade to the US. So today, for China, Southeast Asia is arguably now more important than the US.
This is how the decoupling is working, and it’s not working in favor of the US. It’s actually working in favor of China because China is getting bigger and bigger inroads in the markets that are going to be the growth markets of the future…
China’s growth is no longer about selling plastic toys and tennis shoes. It’s now selling cars, earth-moving equipment, solar panels, telecom switches, and it’s selling it not to the US, not to Europe, it’s selling to all these other emerging-market countries.”
And according to the International Institute for Management Development (IMD), Chinese corporate profits have exploded higher over the last few years.
“First, our analysis reveals that the Chinese corporate dragon has indeed awoken, but only recently. Taken together, Chinese firms created little value before 2019. The economic profits generated by publicly listed Chinese firms rose from just $26bn in 2019 to almost $249bn in 2023. If we adjust these values to take non-listed firms into account, the rise from $53bn in 2019 to $620bn is even more impressive.”
So no, it didn’t happen. China’s trade surplus has more than doubled while corporate profits are up almost 10x over the last few years.
Looking at current valuation metrics for the Chinese stock market relative to the US stock market is eye opening. The current forward p/e ratio for the Chinese stock market is just 10.7x versus 21x in the US. Equity Risk Premium, the added yield provided by stocks above the domestic treasury bond yield, in China is also massively larger than in the US.
Based on our 10 Year Expected Return Model, the Chinese stock market has expected annualized returns of 11% over the next decade.
Obviously, China has its problems. The CCP has further consolidated its control over the economy, population is declining and there is a significant concern with the trustworthiness of Chinese corporate reporting, but their stock market has reached very cheap price levels and its worth keeping an eye on.
