In a word, China has global investors unnerved.
The nation’s stock market dropped more than 50% from early 2021 through February of this year and foreign direct investment is tumbling for the first time in more than a decade.
Contrast that with the previous 20 years—through the end of 2023— when money poured into China: foreign direct investment, venture capital, private equity, and portfolio flows. At its peak, China represented about 35% of the MSCI EM Index, but that share has slipped to 25%.
The country regularly reports robust GDP figures, but those are usually followed by analysts’ caveats that remind observers that the world’s second largest economy is centrally controlled by the Chinese Communist Party (CCP).
And the man atop the CCP? President Xi Jinping, who the world has grown to understand is very different from the previous leaders in China. We’ve been wary since he ascended to the Presidency in 2013, but for others, the first warning sign came when he suspended the IPO for Ant Group in late 2020.
By now, there seems to be a widespread realization that investing in China is precarious, because its treatment of investors and individuals in the business and financial community is, to some degree, capricious.
Although, we contend it may be less capricious than people think, because it doesn’t appear random—it appears to be absolutely honed to a single purpose which is to enhance the power of Xi and the CCP’s control over the economy.
Meanwhile, Xi faces an abundance of issues in the domestic economy, driven in large part by its over-investment in real estate—as much as 30% of the economy was in buildings, apartments, and houses at its peak. But slumping sales, new builds, and new developments are a drag, and contributing to debt-laden havoc among large developers.
The purest view? Many direct investors have concluded China is an inhospitable place to invest.
Chinese Stock Market Trading Below Pre-Pandemic Levels
Source: Bloomberg
Outside Investors Backing Away
Aside from the stock market, a significant disinvestment from China appears to be underway. For all of 2023, foreign direct investment into the country declined on a year-over-year basis for the first time since 2012, falling 8.0% from year-earlier levels. Then, through the first three months of 2024, it fell 26% from first quarter 2023 levels.
Essentially, if you're a major global multinational corporation thinking about where to invest with your next plant, it’s presently not likely China—and probably won’t be for an extended period of time.
Such trends exacerbate China's other domestic economic issues, as the country needs technology and capital from the West, but it appears as though Xi has basically shut down developing needed connections while promoting his own policies. So, it’s a real struggle for China, both strategically and tactically, and could continue to be for the next 10-15-20 years.
It doesn't mean that you can't make money investing in stocks here and there, as there are some that are going to do well and some that won’t. That's for individuals to determine.
Foreign Domestic Investment in China Falls Sharply 2022-24
(change in % from year-earlier levels)
Source: Ministry of Commerce of the People’s Republic of China via Trading Economics,
Funds Are Leaving the Nation as Well
Historically, China has been a nation of savers, so there's a lot of money circulating within the general populace, but stories of moving cash out of the country are becoming more common.
Given the strict limitations on how much you can transfer out of China, we’ve heard about the rise of effectively blind exchanges, in which cash is handed to strangers, who are trusted to deposit the funds elsewhere—frequently Hong Kong.
We’ve seen this before in Latin America, where money flows out of the region and into the global financial system. The same thing is now happening in China, and it’s occurring within the lower middle class, the upper middle class, and the very, very wealthy.
We believe that illustrates how desperate the Chinese are, at many socioeconomic levels, and it seems to reflect a growing loss of faith in the Chinese system. We believe part of that stems from what has been broken, in terms of the policy towards the big tech companies and towards private capital.
Basically, any company of import in China has CCP representation within the company, checking on what’s going on, including who and what they’re investing in, etc. So, it's not free. And the country is becoming less free by the day, with interventions into the private lives of individuals, the monitoring of computers, and more.
So, put yourself in in the position of a 35- or 40-year-old Chinese person who has been working 15-20 years. You’ve saved and maybe you bought an apartment. Maybe even a second apartment. Those valuations have gone down. Maybe the second apartment wasn't even delivered. But you've got a mortgage on it, and you put money down on it. You're not very happy.
We would suggest that, given on top of that the growing repression in the country, you're thinking “Well, this is not really a great place, and I don’t believe I want to keep my money here anymore.”
Given that, we’re hearing many stories about how people are finding ways to get their money out of the country—it’s not staying there.
And that's a problem for the country.
Maintaining a West-Friendly Face
Chinese officials are working to reverse the tide, going out and trying to encourage U.S.- and Europe-based companies to invest in their country.
But put yourself in the shoes of a U.S. trade representative meeting with a Chinese trade representative. Wouldn’t your first question be “Why?” As in “Why should we invest more in your country when you are spying and stealing our technology every day?”
It seems like the Chinese want the investment, but won’t stop undermining companies that set up there.
At one time, many large global companies felt they had to go to China. They were seduced by its scale and size, which is understandable. We believe, however, that when Xi came into power, a very different tone emerged.
It took some time, but it now appears that the perspective of many foreign investors has finally crystallized along similar lines and they are better seeing the risks.
And those who don’t, consider how much they have invested in China, one way or another. That’s a conflict of interest. If you're trying to make a clear and present assessment of what the future in China looks like, you’ve got to allow for that.
It Wasn’t Always This Way
Under socialist rule through 1978, China took steps toward aligning with the global economy that year by implementing significant economic reforms. The changes hit warp speed in late 2001 when the country joined World Trade Organization (WTO).
WTO membership really brought China into the global economy as it became a huge manufacturing base, progressing from lower value products to the numerous high value-added products of today.
That evolution fueled a huge surge in employment and income, and it advanced China's GDP tremendously. The country essentially became a major manufacturing platform for the world, and as a result, it was very successful, gaining a lot of wealth. Although much of that was confined to mostly to the coastal areas of China, and it didn't necessarily get to the far reaches of inner and northern China.
But it was a very successful process, and the rest of the world also benefited greatly by importing cheap goods. The counter to that was that a lot of workers in the developed world lost jobs that were effectively exported to China.
The Xi Effect
Where we believe China’s trajectory changed was when Xi came into power as President in 2013. Having completed two five-year terms, he recently started his third term, thanks to his successful effort to change the system within the supposed rules of the CCP. At this stage, people believe that he's essentially going to be President for life.
In any case, he was able to consolidate his position through very aggressive tactics, including corruption allegations against others that allowed him to sideline much of his opposition. People think that the CCP is monolithic, but it is not. There are many different pillars of power within the CCP, but Xi has been able to significantly silence those rival power pillars, and that's allowed him to become very authoritarian.
Meanwhile, the relationship between China and the rest of the world has been changing significantly: China has become much more aggressive in its foreign policy; much more aggressive in terms of spying and stealing technology, etc.; and much more repressive domestically.
Consider the tone Xi set for big technology companies about 3½ years ago, when he stopped the IPO of Ant Group, the fintech subsidiary of Alibaba. It happened very suddenly, very last minute, and shortly thereafter, founder Jack Ma essentially disappeared for a little while. There have been other disappearances of various other technology leaders and banking leaders, and we’ve seen such developments give the rest of the world pause.
Continued Gloom on the Horizon
Looking ahead, we believe the situation in China will remain very messy for a while—a big reason is the lingering question of what happens with Taiwan?
Given the recent discovery of wide-scale corruption in the Chinese military, we believe it’s highly unlikely that an invasion of the island is imminent. That doesn't mean China won’t continue to invest heavily and rattle a lot of cages. Plus, they could try to quarantine Taiwan, although they may not be well-equipped to do that.
Overall, however, what we see is a messy situation getting messier. While it doesn’t appear likely to devolve into war in the next few years, we also don’t see it as being resolved. Nor do we see the path for China changing, unless Xi is no longer President of the country.
That's not an impossibility, as there are different pillars of power within China, but again, Xi has done a good job of eliminating his rivals, so in the end, we see a poor situation that's likely to get poorer.
For the people of China and for investors worldwide.
