Monday, June 10, 2024 06:00 AM EDT
By Dominic Petrone, Data Analyst, Bedel Financial Consulting Inc.
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There are many risks associated with investing in China. Like all investing decisions, it comes down to whether the potential gains outweigh the risks.Understanding the risk/reward profile is an important first step.
Geopolitics
The normalization of international relations before China’s 1990 stock exchange reopening led to high growth and stability in the Chinese economy. China’s seemingly constant high growth has made it a major consideration for foreign investors.
The first risk usually considered when investing in China is its geopolitical situation, especially with the US. The Chinese Communist Party’s (CCP) main goals are not necessarily economic growth but maintaining internal control, expanding their sphere of influence, and reunifying with Hong Kong, Macau, and Taiwan.
This leads to inefficiencies in the Chinese economy due to underemphasizing or overemphasizing specific industries. Restrictions on the Chinese economy imposed by China itself or its geopolitical rivals, like tariffs and sanctions, also have an effect. If war broke out between China and Taiwan, the global effects would be significant, but even more so in China.
Domestic Worries
The risks in China are not all geopolitical. There are also major domestic issues that cause concern. The COVID-19 pandemic hit the Chinese market hard. It had its lowest years of economic growth since the death of Mao Zedong in 1976. Though it looked like China recovered from this quickly in 2021, its economy fell nearly back to 2020 levels in 2022, with slight but steady growth since. China also has some demographic issues that many countries worldwide are currently experiencing, and that is an aging population.
With unemployment for Chinese youth (aged between 16-24) around 15%, this can be a concerning trend for their future workforce. More money will need to go towards healthcare for the aged population, and the upcoming workforce struggling to enter the job market could lead to significant holes in the economy.
This data was so concerning that China stopped reporting it in June 2023, when it peaked at 21.3%. They started reporting again in January 2024 after they excluded unemployed students, something that is rarely done elsewhere. The unreliable or incomplete data that comes from China also sparks hesitation.
The Positives
The risks of investing in China can appear too burdensome, but there are other considerations. Chinese investments have low valuations to compensate for the perceived risks. As a result, the CSI300, the top 300 stocks traded on the Shanghai Stock Exchange, has a price-to-earnings ratio of 13. This is around half of the average PE ratio of S&P500 stocks. These valuations can create great value investments for investors.
Specific industries that the CCP favors or that are in high demand in China also benefit. As China’s economy continues to grow and its population ages, the healthcare and service sector will likely be a larger focus.
Conclusion
Unique opportunities within industries combined with a low valuation can create an environment for great investments. And while China has such an environment, the risks are quite sizeable.If you want to invest in China, it can be part of a diversified portfolio, but just be prepared for volatile returns.
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