The China Conundrum

Can we afford to be confident about the global economy? Most of us, barraged by headlines about war, inflation, fuel spikes, chip shortages, political unrest, a growth-stock collapse, an IPO dearth and resurgent coronavirus cases in China and Hong Kong, would say no. The global economy looks gravely wounded. But let me flip the question: Can we afford not to be confident about the global economy?

Confidence, after all, is a mood, not a fact. It’s always a smart financial exercise to challenge our moods with their contrarian opposites. Example: Fast-growth internet stocks like Sea and PayPal had been significantly overvalued since 2016 and crazily so since mid-2020. Both are fine companies, but they were priced for perfection. Then more so, as they continued to float up for another 18 months. Confidence became euphoria. Late investors crashed the gates. They always do.

Back then, the burden was on skeptics to prove their case. Today, the onus is on optimists to persuade us that abundance hides within the problems, and long-term growth horizons will return. These optimists say that Ukraine-Russia will resolve soon. That oil prices will recede to somewhere between $40 and $80 a barrel. That new technology will overhaul supply chains to be efficient, resilient and predictive. That inflation will peak in 2022. That central banks will get it right, neither too hawkish nor dovish.

The most interesting divide in the world between mood and fact is today’s Chinese stock market. Call it the China conundrum. China’s GDP has grown by about 4,000% since 1992. China’s stock market has grown, well, not so much. Within Morgan Stanley’s MSCI world tally of stock returns, the China index has grown by only 56% in 30 years—a pathetic annualized rate of only 1.5%.

The fact of China’s 30-year economic growth is astonishing—surely a modern wonder of the world. But China’s stock market performance over that period has been shockingly poor. Why the difference? Some of this is due to lack of transparency, insider manipulation, and so on. However, one could argue that the same risks exist in all emerging markets. Yet MSCI’s emerging market index has had 7.2% annualized returns since 1992, and 8.5% annualized returns if China is excluded.

The China conundrum is the gulf between fact and mood. This column is critical of President Xi Jinping’s recent authoritarian moves against entrepreneurs and investors. Yet the global investor mood has probably overshot the actual results of Xi’s moves. China’s stocks trade at a forward P/E ratio of 11. By contrast, the American S&P 500 has a forward P/E ratio of 25—and few would call American investors bullish.

Here’s another, and related, China conundrum. China is minting plenty of billionaires. This year’s World’s Billionaires list shows that China had 607 billionaires, topped only by the U.S. with 735. But when it comes to rich companies, China has no publicly traded outfits with market caps that compare with America’s four richest companies—Apple, Microsoft, Amazon and Alphabet (Google)—which total well above $8 trillion.

Remember the 2008-2009 crash? We called its recovery the New Normal. Today it feels like the New Abnormal. Conundrums are everywhere! But within each conundrum is vast opportunity if you look.