By Investment Associate Bobby Adusumilli, CFA.
2021 was a turbulent year for Chinese stocks. Partially due to concerns about government involvement in businesses, human rights, and the repercussions of the COVID-19 pandemic, the MSCI China Index declined nearly 22% in 2021, compared to a 10% gain for the MSCI Emerging Markets ex China Index.[1][2][3] To demonstrate the significance of China to emerging markets stock performance, the MSCI Emerging Markets Index fell roughly 2.5% in 2021, of which Chinese stocks make up approximately 29%.[4]
Source: MSCI, as of December 31, 2021. Please see Important Disclosure Information.
As the above illustrates, Chinese stocks and emerging markets stocks more generally have had rough performance relative to the United States over the past ten years.[5] However, that does not mean that investors should abandon emerging markets stocks. As the above fundamentals demonstrate, emerging markets (including China) stocks are significantly cheaper than US stocks. Additionally, even with the poor performance in 2021, Chinese stocks have outperformed other emerging markets stocks over the past ten years while also having similar forward-looking valuation metrics, suggesting Chinese stocks can help emerging markets investments.
Demographic trends seem to indicate there will be more economic growth in emerging markets like China compared to more developed markets such as the US.[6] To illustrate this trend, the below graph shows the gross domestic product (GDP) - a measure of the goods and services produced in a country during a period of time - of China and the US. In 1980, China’s GDP was 11% of the United States' GDP; by 2021, China’s GDP had grown to 86% of the United States' GDP.[7]
Source: “GDP, current prices“. International Monetary Fund, imf.org/en/Home. Please see Important Disclosure Information.
Many of the world’s top investors are also investing heavily in China. For example, according to the Wall Street Journal, venture-capital investors invested $129 billion into more than 5,300 startups in China in 2021.[8] These investments made up roughly 20% of the approximately $643 billion in global venture capital investments in 2021.[8][9] For comparison, Chinese stocks currently only make up 4% of global stock market capitalization as measured by the MSCI All Country World Index (ACWI).[10] This venture capital activity suggests that the aggregate market capitalization of Chinese stocks will grow considerably in the years to come.
While the various investor concerns about China are legitimate, it is important to note that among companies on stock exchanges in developed markets (including the US), nearly 20% of their revenues come from emerging markets, with China being the single-biggest revenue source.[11] Given the global nature of business today, it is very difficult to invest in stocks without having direct or indirect exposure to China. Investors worried about certain practices in Chinese companies can invest in ESG (Environment, Social, & Governance)-focused emerging markets mutual funds and ETFs, which can help people decrease exposure to companies that don’t match their values. Or investors can invest in emerging markets mutual funds and ETFs that exclude Chinese stocks.
China has been growing rapidly from an economic perspective, with the amount of people in the middle class rising significantly, as well as innovative companies starting in China at a number only rivaled by the United States.[12][7] Given all of the above, we believe Chinese stocks are positioned to have positive expected returns over the intermediate- and long-term.
Important Disclosure Information & Sources:
[1] “Chinese Companies Listed at Home Surge While Crackdowns Clobber Those Abroad“. Rebecca Feng, 03-Jan-2022, wsj.com.
[2] “MSCI China Index (USD)“. MSCI, 31-Dec-2021, msci.com. The MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). The index covers about 85% of this China equity universe. Currently, the index includes Large Cap A and Mid Cap A shares represented at 20% of their free float adjusted market capitalization.
[3] “MSCI Emerging Markets ex China Index (USD)“. MSCI, 31-Dec-2021, msci.com. The MSCI Emerging Markets ex China Index captures large and mid cap representation across 24 of the 25 Emerging Markets (EM) countries excluding China. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
[4] “MSCI Emerging Markets Index (USD)”. MSCI, 31-Dec-2021, msci.com. The MSCI Emerging Markets Index captures large and mid cap representation across 25 Emerging Markets (EM) countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
[5] “MSCI USA Index”. MSCI, 31-Dec-2021, msci.com. The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. The index covers approximately 85% of the free float-adjusted market capitalization in the US.
[6] “Real GDP growth“. International Monetary Fund, imf.org/en/Home.
[7] “GDP, current prices“. International Monetary Fund, imf.org/en/Home.
[8] “China’s Startups Are Awash With Money as Beijing Shifts Focus to ‘Hard Tech’“. Liza Lin, Jing Yang, & Keith Zhai, 13-Jan-2022, wsj.com.
[9] “Global Venture Funding And Unicorn Creation In 2021 Shattered All Records“. Gene Teare, 05-Jan-2022, crunchbase.com.
[10] “MSCI ACWI Index (USD)“. MSCI, 31-Dec-2021, msci.com. The MSCI ACWI captures large and mid cap representation across 23 Developed Markets (DM) and 25 Emerging Markets (EM) countries. The index covers approximately 85% of the global investable equity opportunity set.
[11] “The Ever Given, Suez Canal and Impact of One Stuck Ship on the Global Economy“. Avantis Investors, March 2021, avantisinvestors.com.
[12] “China’s Influence on the Global Middle Class“. Homi Kharas & Meagan Dooley, October 2020, brookings.edu.
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Statements contained in this article that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
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