Chinese stocks no longer the best exposure for its economy
When the economic outlook is positive, companies generally expect higher earnings and investor risk appetite increases, leading to higher stock prices. However, this does not appear to apply to Chinese conceptual stocks.
On the one hand, the Chinese economy is doing exceptionally well. According to the World Bank’s Global Economic Prospects report, the Chinese economy is expected to grow by more than 8% this year and by 5.3% on average over the next two years. The two-year average growth rates of industrial enterprise profits above the designated size, international trade and foreign direct investment in the first seven months of the year reached 20.2%, 10.6%, respectively. % and 12.3%. Inflation and unemployment rates based on the Consumer Price Index (CPI) remain low. In addition, the credit to the non-financial sector / gross domestic product (GDP) ratio has increased only 20% from the pre-COVID-19 level, and the ratio has been declining steadily since the third quarter of 2020.
In contrast, Chinese equity trading on US stock exchanges has fallen 20% this year. Naturally, stock prices in the private tutoring sector have been heavily affected by the new rules. But even most of the blue-chip large-cap stocks also suffered significant losses. Many investors fear that China’s reforms and new regulations will harm its vibrant tech sector, which is at the heart of the country’s highly successful innovative business model.
But things are not that simple.
The Chinese economy has an inexhaustible flow of internal energy for sustainable economic growth, not only because Chinese market mechanisms promote the reallocation of resources, but also because Chinese institutions adapt to creative destruction.
Creative destruction requires free markets and competition laws that allow new entrants. If established companies abuse their dominant market position to exclude new entrants, companies with new technologies will be unable to challenge older companies.
This is clearly an abuse of dominance of Alibaba’s stipulation that merchants sell exclusively on its platforms in order to hamper the development of its competitors. Additionally, Chinese tech giants potentially stifle disruptive innovation by constantly acquiring new challengers and start-ups and continually expanding their product lines.
The reallocation of resources and creative destruction are very evident from the perspective of Chinese listed companies. The CSI 300 index has been calculated since April 8, 2005 and considered to be the Chinese counterpart of the S&P 500 index. The four main constituent industries at that time were steel, thermal power generation, and transport facilities. and coal mining. Today, the four main sectors of the CSI 300 are securities firms, banking, electronic components, and healthcare.
Although 51 of its constituents from then, including China Merchants Bank, Kweichow Moutai and Wanhua Chemical, are still constituents of CSI 300 today, the vast majority of its constituents then have abandoned CSI 300, like Chunlan Group , Lucky Film and Huadian Energy. Twenty-five of them have even been delisted or bought by other companies.
Since its inception, the annual “churn rate” of the CSI 300, or the rate at which stocks are removed from the index, has remained relatively constant at 16%, significantly higher than that of the S&P 500 at around 4%; that is, the average lifespan of companies as a component of the CSI 300 is only six years, far less than the 25 years of the S&P 500.
As part of the process of creative destruction, existing wealth is constantly depreciated to make room for the creation of new wealth. Ultimately, however, the rapid creative destruction helped the new winners hugely overtake the old ones. When the CSI 300 index was first published, the index was pegged at 1,000 points and the total market capitalization of its constituents was only 2.2 trillion renminbi ($ 341 billion); today, the index is at 4,933 points and the total market capitalization of its components reaches 48.5 trillion renminbi. During the same period, the weighted average price / earnings ratio of the index even declined slightly to stand at 16 today.
Today, the Chinese economy is so dynamic that some Chinese companies are already at the global technological frontier. The most advanced technological innovations in the world are taking place in the fields of artificial intelligence (AI), clean energy, robotics and biotechnology. China has a comparative advantage in industrial innovations, including solar power, battery technology, 3D printing, industrial robotics, and innovative materials. China is trying to catch up with the United States in AI and is lagging behind several countries in biotechnology.
Chinese companies are now encompassing all technological pathways, product components and market segments in the solar energy and electric vehicle industries, enabling domestic manufacturers to continually improve their techniques and reduce costs. SAIC, for example, produces electric vehicles (EVs) for as little as $ 4,000, and 300,000 of them were sold in China last year, making it one of the largest vehicle companies electricity from the planet.
As disruptive innovation in energy storage continues to drive the cost of electric vehicles to much lower levels than conventional cars, car sales in China could skyrocket, propelling family car ownership towards new heights. A rapid change in the Chinese way of life is likely to occur, just as it did when Chinese companies started producing high-speed trains and building high-speed railways or when they started. to produce affordable but high-quality smartphones and telecommunications equipment.
So, unsurprisingly, these industries are hot spots at the forefront of the Chinese economy and offer tempting investment prospects. In the first seven months of this year, the total value added of industrial enterprises above the designated size grew at a two-year average rate of just 6.7%, while electric vehicles and industrial robots have increased. increased to a two-year average of 46.5% and 34.8% respectively. Stock prices of electric vehicles and solar energy companies listed on Chinese stock markets rose 40% this year, while the CSI 300 index fell 7%.
On the US stock markets, Chinese stocks are heavily focused on one sector: information technology. Although a handful of Chinese companies listed on the US stock markets are in the second largest industry, they are nowhere near the size or market position of their peers listed on the Chinese stock markets. As a result, Chinese concept equity investors have struggled to take advantage of the renewed strength in the Chinese economy this year.
Due to the new regulatory requirements, fewer Chinese companies will consider entering the US stock markets in the future. To take advantage of China’s comparative advantage, asset managers might consider expanding their coverage of Chinese A-share companies.