Is Chinese Market Still Investable?

Is the Chinese market still investable? from CNBC.

I joined Sara Eisen on CNBC’s The Closing Bell to chat about Chinese stocks.

Emerging markets have underperformed the U.S. market since 2009 for various reasons: political instability, currency weakness, commodity price weakness, and cyclical preferences. But after years of outperformance, U.S. stocks are now very expensive relative to emerging markets. For a long-term allocation, it makes sense to underweight U.S. equities and overweight emerging markets, including China.

That said, a little patience might be warranted here. Chinese stocks are in bear-market territory, and the pain might not be over yet.

The recent slowdown in China’s GDP growth is worrisome. China’s economic statistics are notoriously unreliable, but the general consensus is that growth of 6.5% is the threshold China needs to continue employment gains. Well, Chinese growth has slowed to 6.5%… and appears to be losing momentum.

Because hard stats are unreliable, you have to look for anecdotal evidence. Recently, China had to deal with angry mobs marching in the streets demanding that the government “do something” to prop up sagging home prices.

This puts the Chinese government in a bad position. Home construction and related industries make up anywhere from 15% to 30% of the Chinese economy. If the government curtails new construction to prop up prices, that kills growth. But if they boost construction to keep the economy moving, they add new supply to an already oversupplied market.

Chinese builders are also highly leveraged. I’m not necessarily worried about bad loans because China can pretty easily prop up zombie banks if they need to. It’s more an issue of diminishing marginal returns, or getting less bang for the buck. The last time China faced a slowdown, they went on a spending spree for construction and infrastructure. It’s hard to see that being effective again.

And finally, there is the issue of tariffs and more broadly of aggressiveness towards China by the U.S. and Europe. Chinese theft of intellectual property has been a “known issue” for years, but it seems that sentiment here has reached a tipping point. The West tolerated an imbalanced trade relationship with China because there was a belief that a more capitalistic China would also be a more democratic and more Western-friendly China. It didn’t really work out that way. As China has grown wealthier, it has arguably become more hostile to the West, and it certainly hasn’t become more free or democratic.

Western leaders can legitimately ask why they allow a trade relationship that disproportionately helps a geopolitical rival.

The broader question is whether this is a cyclical bear market (which could end quickly) or if this is simply the next phase of a longer-term secular bear market that started in 2015. In either case, you might get tradable rallies. But it’s likely too risky for most investors to consider a long-term buy and hold investment here.

 

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