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Why Chinese markets remain a BUY

Updated: Apr 9

Most of you might have noticed that in the past few weeks the tone between China and many Western countries has become noticeably rougher. In addition to the usual rhetorical skirmishes, Europe imposed sanctions on China for the first time in over 30 years. China responded with counter-sanctions and additional calls to boycott some foreign brands as a result of these firm's public statements – the Swedish fashion house H&M is the perhaps most famous case.

View from a tea house near the Houhai (后海) Lake in Bejing

The unfortunate dilemma


Even some Chinese I know are amazed at the harshness with which China now appears to the outside world. Ultimately, it is a certain national pride in combination with the inner conviction that one can now afford to fend off criticism that is unjustified from China's point of view. Perhaps the following quote from a Chinese diplomat sums it up best:

The Chinese people do not allow some foreign companies to eat Chinese food and smash Chinese bowls.

I am well aware that this entire topic is very complex given the interplay between ideological and economic components. The quandary is that many companies and countries literally cannot afford to take a clear stand. Because on the one hand there are local shareholders and consumers, on the other hand, there is China, which single-handedly generated a third of global economic growth in the last decade. While China accounts for only around 5% of H&M's total sales, there are companies that are much more dependent on China these days (for more thoughts on that, check out my latest podcast episode Did we become too much dependent on China).


Assessing the entire situation concerning politics and human rights does not fall within my area of ​​competence, nor does it in any way fit within the scope of Dragonfolio China. Instead, for me as an economic observer and investor, the question is, can I keep investing in China? To answer this question, there are two primary factors that I want to outline in the following.


Why Chinese markets will continue to rise

We always have to be clear about what we are referring to: Anyone who invests in Chinese stocks is not investing in a country or a government but in Chinese companies and related markets. We should also be aware that politics and economic regulations have an influence on such companies and thus ultimately their share price. However, as long as governments do not act in an economically harmful manner (e.g. through regular price manipulation) and as long as there is enough growth in the market, companies will continue to appreciate in the long-run. This scenario applies under the assumption that enterprises have the ability to use this potential.


All three premises (market economy, growth, profitability) are given in many Chinese companies nowadays, as the Dragonfolio China portfolios proof. Even the recently much-cited monopoly regulations in China will not drag such well-performing companies down. The reason for this is quite banal: China is interested in strong technology companies. Therefore, they will not commit economic suicide and slow down top companies. The only question for many Chinese companies is in principle how fast they grow and in which markets outside of China they can expand (as a bonus, so to speak).


Why you can continue to benefit

There is still the perceived risk that Chinese stocks will be denied access to Western equity markets. At the moment, I still dare to doubt whether this will really happen across the board. Though in case it does, almost all of the Chinese companies are already protected against this threat through their second listings. More and more Chinese companies that have their first listing in New York are striving for a second listing in Hong Kong. Incidentally, this has been announced by the popular online travel agency Trip.com this week following many other famous pioneers such as Alibaba, JD.com, and Baidu. Hong Kong is a very well regulated and transparent financial market and accessible to foreign investors.


Another parallel trend is that Chinese companies in Hong Kong will get an additional listing at the Shanghai stock exchange. A well-known recent example is Xiaomi. This movement also lowers the threshold for domestic (Chinese) investors. Many people don't even know this, but lots of Chinese until today are unable to invest in their own domestic companies, such as Alibaba, because they lack access in their own country.


In case the "return home" of Chinese companies becomes the new normal, we might see an unprecedented equity boom in China, where technically enormous amounts of equity are available. At the same time, international investors will continue to invest in these companies, which in the double combination would be positive for us as investors in the long term.


In summary, it can be said, that a loss of access to US capital markets, will not mean that we can no longer buy Chinese stocks, nor will it limit China's ability to raise capital in the long term. The stock market values ​​of most Chinese companies will continue to grow over the next few decades and will outperform many Western markets.


Important conclusion

After all, I find it important to emphasize again that, firstly, we don't have to worry about stock investments in China and, secondly, of course, we should still hope that there will be no extreme decoupling between the so-called Western and Eastern markets. Although a lot of things appear very negative these days with a lot of support from various media channels, it is a very exciting time nonetheless, especially for China observers.


I constantly conclude that there is regretfully still very little understanding on both sides and I will therefore within my means try to improve this. Fortunately, there seem to be more and more people who think similarly and try to enhance relationships indirectly through their work. In the current tense environment, there should not only be a yin and yang (black and white) but we probably also have to learn to deal better with some gray tones.


Stay curious,


Eric

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