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WITH 2024’S ELECTION underway, many folks are asking, do politics affect investment markets? On that score, there’s good news: The data say markets in the U.S. have delivered good—and roughly equal—results under both Democrats and Republicans.
But that doesn’t mean politics never has an impact. Look outside the U.S., and you’ll see that a country’s political structure can have enormous implications. To the extent that your portfolio is diversified internationally, it’s important to keep an eye on developments elsewhere. At the top of the list: China, which is now the world’s second-largest economy.
For years, China was attractive to investors because of its rapid economic growth. But things have changed in recent years. Between 2021 and 2023, the MSCI China Index lost more than 18% a year, while the S&P 500 gained 10% annually. Over the past 10 years, the Chinese market has returned just 0.9% a year, while the U.S. has climbed 12%. What’s driving these disparate results—and should investors expect more of the same?
Primarily at issue has been a set of policies initiated by Xi Jinping’s government in 2020. In November of that year, Chinese authorities halted the planned initial public offering (IPO) of Ant Group at the last minute. Ant is a financial technology company controlled by entrepreneur Jack Ma. By way of background, Ma was also the founder of Alibaba and is probably the country’s best-known business figure.
Why did Beijing squash Ant’s IPO? While there was no official word, most observers believe it was in response to comments Ma had made in the month prior to the planned offering. Ma had criticized China’s banking system, saying it had a “pawn shop mentality,” and also criticized government regulators. In the words of one China analyst, “He apparently crossed the invisible red line for what can be said and done in Xi Jinping’s China.”
Soon after, Ma was forced to give up voting control of Ant Group, and the company was fined nearly $1 billion. The government also punished Ma’s Alibaba with a $2.5 billion fine. Both of these enforcement actions were seen as arbitrary. But perhaps the story’s most disturbing aspect was that Ma then disappeared from view for several months, raising questions about his well-being.
Ma later reappeared, but with a lower profile. According to a colleague, he was “doing very, very well” and had taken up painting. It was an extremely odd turn of events for someone who had at one point been China’s wealthiest person. If this had been an isolated incident, perhaps it could have been explained away, but the government’s actions against Ma were just the beginning.
Beijing broadened its campaign to target other powerful companies. Since then, many more firms—mostly in technology—have been fined or sanctioned and, as a result, seen their stocks fall. Tencent and JD.com have seen their shares drop by half.
Despite the negative impact on investment markets, Xi’s government shows no sign of slowing its efforts to weaken powerful companies. In fact, just last week, the planned IPO of online retailer Shein hit the rocks when Chinese regulators announced a “security review.” This was reminiscent of the move Beijing took against Didi Global in 2021. Didi, which runs a ride-hailing app similar to Uber, had just completed an IPO on the New York Stock Exchange when the government opened an investigation. The charges were varied and vague. But in the end, it was forced to delist, punishing both the company and its shareholders.
In addition to the negative effect of these moves on share prices, second-order effects have now started to occur. International investors are showing a growing wariness toward China, as evidenced by last year’s drop off in foreign direct investment (FDI). FDI dropped to $15 billion in 2023, down sharply from $180 billion the year before. Prior to that, FDI in China had been above $150 billion every year for more than a decade.
Because of Beijing’s penchant for punishing its most successful companies, observers are now asking whether Chinese stocks are worth purchasing at any price. Desmond Shum is the author of Red Roulette and knows China well. In a recent online post, he asked, “How should China companies be priced? How much discount should be priced in? Erratic behaviors of CCP [Chinese Communist Party] since Xi and growing geopolitical risks make China uninvestable.”
At the same time that these policies have caused share prices to crater, authorities have taken steps to try to prop up prices. Since the fall, regulators have been providing “window guidance” to institutional investors in China, the effect of which has been to prevent them from selling stocks. But this heavy-handedness has only created new distortions in the market.
As one Shanghai-based investor explained, window guidance “creates delayed selling pressure, but it’s not like you can postpone that forever. Market sentiment will eventually dictate performance.” In other words, this window guidance has created an additional problem: Share prices now sit on an even shakier foundation.
Investors have come to distrust the Chinese government both in what it does and in what it says. Indeed, even basic economic data aren’t viewed as reliable. In 2023, according to Beijing, GDP grew 5.2%. But many view this as an essentially made-up number. Research firm Rhodium Group estimates that growth was below 3%. One well-informed investor I spoke with called the government’s 5.2% “a joke.”
Further challenging its economy, China is now contending with a demographic problem. Decades of efforts to slow its population growth have had unintended consequences. In 2023, fewer babies were born than in 2016, the year China abolished its one-child policy. The fertility rate is now close to 1, far below the 2.1 that’s required for a population to remain level. And unlike the U.S., China receives virtually no benefit from immigration.
This trend is a problem for investors because population growth is a key contributor to economic growth. In simple terms, a growing population provides a greater number of customers for businesses to sell to. And more workers also help drive economic activity. An aging population, on the other hand, slows an economy and places greater burdens on public finances.
Warren Buffett often says that there are no called strikes in investing. This is a baseball term meaning that investors are never compelled to take any particular action. They have the luxury of waiting for another opportunity. Because of all the challenges described here, my advice in recent years has been to simply steer clear of any investment in China. If you want emerging markets exposure, look to a fund that excludes China, such as the innovative Freedom 100 Emerging Markets ETF (symbol: FRDM).
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X (Twitter) @AdamMGrossman and check out his earlier articles.
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The tension and hostility between the U.S. and China largely result from geopolitical competition. This is extremely unfortunate and a lose-lose proposition for the people of both nations.
Mainstream Western press and pundits generally have a superficial understanding of China’s political system and economy. Their views toward China are often colored by geopolitical concerns and domestic issues, particularly the inability to address the consequences of globalization and technological changes. https://www.youtube.com/watch?v=NeIXR8vcnXw
There is no doubt that China confronts major challenges for its future political, economic, and social developments. But this is also true for all other nations including the United States and other developed nations.
Like Warren Buffet, I would not bet against America. Nonetheless, I am not ready to bet against China either.
While geopolitical competition certainly has economic consequences, the examples cited in Adam’s posting illustrate that many of China’s economic problems are self-imposed.
I completely concur with the analysis.
Countries that create wealth follow the rule of law, period. This is why Singapore, Switzerland, Eurozone are wealthier than say Russia, Saudi Arabia etc.
I will not invest in Chinese companies, no matter how cheap they get.
The issue I find with FRDM is that, despite excluding Chinese stocks, the ETF allocates nearly 40% of its assets to two countries: Taiwan and Poland. Considering geopolitical risks as a reason to avoid China, it’s worth noting that both these countries pose significant risks due to their strategic interests with Russia and China, respectively.
Perhaps, opting not to invest in emerging markets altogether could be a more prudent approach.
The macro issues described by Adam are exacerbated by the micro issues encountered by everyday Chinese. The Xi dictatorship inflicted horrors on its own people during the pandemic, particularly in Wuhan, and effectively demolished the faith that their people had in their government. The continuing oppressive policies imposed by Xi are, in my view, the reason that young Chinese are no longer starting families or businesses — their optimism has been obliterated. They see their country spiraling downward.
What an astonishing change this is from just one generation ago, when you could walk through the Pudong business district of Shanghai and feel the adrenaline flowing down the street, and young people were so excited for the new opportunities available to them. My wife and I seriously considered moving permanently to China back then. We were ready to invest our lives. Now we are celebrating the successful conclusion of a bitter three-year legal battle to get her family out of Wuhan and into the US, where our nephew now has the opportunities that had been blighted for him back home.
I remember how I used to laugh at China permabear Jim Chanos and his doomsday predictions for the Chinese market back in 2008, and anybody listening to him missed out on some fantastic stock returns. But now China’s situation is clear for anyone to see.
Every time I read something like this, it just makes me glad I don’t have to live in or start a business in China.
15 or 20 years ago, China was a fantastic place to start a business and, depending on location, a nice place to live. Xi and the pandemic changed everything.
The demographic problem was foreseen by a few in China even before the institution of the one-child policy 40+ years ago. Unfortunately for China, with so many people of child bearing age now in the middle class, and far from their agricultural roots, they’ve decided that having children isn’t worth the trouble and expense. The gender imbalance has also had an effect.
Don’t broad Vanguard Group international funds like VEU or VXUS have relatively small direct exposure to China, around 6%-7%, with a smaller ratio in narrower market slices like VIGI or VSS? In the broader context of many portfolios that may leave a bit over 2% at risk. Whether you’re willing to switch your ex-U.S. funds or not, the bigger challenge here might be avoiding indirect exposure. It may be larger and more unavoidable.
I am happy with VEA, the Vanguard Developed Markets Index. China is only 0.17% of their portfolio, with 1.56% Hong Kong and 0.02% Taiwan. If you want more Emerging Markets, XCEM is an index fund that has zero for China and Hong Kong, but watch out for 25.89% in Taiwan. You pick your exposure.
I agree. This is not a problem worth solving unless you’re overweighting emerging markets.