While investors earn so little? Look at the chart below Not much of a return from the Shanghai Stock Exchange the past 10 years despite the rapid growth of the economy. What is the reason investors did not get much of a return? The simple explanation is the quote below. Companies in China do not work primarily for the shareholder.
Early on the hope was it was not going to be this way. Starting years ago the private sector began growing dynamically. Private companies today in China produce 50% of all tax revenue and employ 80% of all workers. There are over 200 Chinese companies listed on U.S. exchanges. Many of the private companies like Alibaba, the Chinese Amazon, have benefitted from newly wealthy Chinese consumers and have seen their stock price soar.
But Xi Jinping, the ever more powerful #1 leader in China, does not trust the private sector. The mantra in China today is, you will work for the greater good of the country — shorthand for toe the line of the Communist Party, or else. Since 2015 life has been made more difficult for private companies at the expense of state-controlled ones. Recently, Alibaba had its hand slapped for trying to grab too much power for its fintech subsidiary, Ant Financial.
In addition, there have been some accounting scandals involving listed companies which have cooled interest in Chinese investments, and recently the SEC has threatened to delist any Chinese company which does not comply with the rule that their books be open to U.S. regulators. Chinese authorities prohibit their companies from complying with this rule.
China is too big a market to ignore and there are potentially great opportunities going forward in technology (chips, AI, electric vehicles), consumer products and healthcare, but it has been frustrating so far. Probably the best way to play China right now is through a diversified mutual fund or ETF (exchange traded fund). In the meantime we will keep our eyes and ears peeled for individual China plays, especially if cross-border relations thaw somewhat under a new Administration.
On the bond side, China is growing but there are twists and turns to be aware of here. In the U.S. today there are just two companies rated AAA – Microsoft and Johnson & Johnson. Chinese rating services however judge over half of all corporate borrowers to be AAA! Pretty amazing. The reason is the implied State guarantee to much of Chinese corporate debt. But debt levels have soared in the recent past and today some companies, even state-linked ones, are missing bond payments and being allowed to go bankrupt. It is difficult to know the quality of Chinese company debt, who is in favor in Beijing, who will be saved and who will not. Buyer beware.
The market for China government debt is a different story, however. You will probably see China sovereign debt become more commonplace in portfolios in the future. With the 10-year U.S. Treasury Note yielding less that 1% and with many similar government issues in Europe at negative rates, China’s government bond return of over 3% looks very tempting. China recently sold dollar debt directly to U.S. investors for the first time. The issue was over-subscribed by four times.