The recent turmoil in China market

Updated: Jul 17

The regulatory clampdown continues in the recent weeks with investigation into Didi Global. And just last week, S&P Dow Jone indices announced it will remove more Chinese companies from its indices as an alignment with US President Joe Biden's executive order to prohibit investment in businesses that are believed to have ties to Chinese military. With these recent events, the tension between U.S. and China persists with the performance of Chinese equities far below the expectations of investors.

(Source: https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/guide-to-the-markets/mi-guide-to-the-markets-us.pdf)


In the recent report by JP Morgan, you can see that the returns in the China market for the past 7 months have been dismal as compared to all other markets (Europe, Japan, U.S. etc). In fact, it's underperforming by quite a bit though the China market also saw the highest return (~30%) in the period (31st Dec 2019 to 6th July 2020). Given the recent drop in the past week, the returns in the China market are even lower than what you are seeing in the diagram above.


So this gets investors worried.


Many are questioning if it still makes sense to continue investing in the China market or this should be a market left untouched for the next few months or even years?


Well, I don't think there is an easy answer to that. But I guess the first question that you should be asking yourself should be the time horizon for your investing journey. If you are looking at quick returns within a 1 year horizon, then maybe the China market might be too risky for you. If your time horizon is a lot longer (eg. 10 years etc), I do think that this recent drawdown in the China market might present a very nice opportunity for you.


Here are my views.


Whatever the China government is doing to the technological companies is not too different from most other developed nations in their response to technological companies of late. U.S and Europe are doing something similar to technological companies. For instance, Joe Biden has signed an executive order targeting anti-competitive practices which will have significant impact for big tech in U.S. The hyper growth of big technological companies have certainly got the governments in most nations worried and that serves as a cause for some of their recent actions. Despite this, I believe that the Chinese government is not looking at destroying all these technological companies as it makes absolutely no sense for them to do that and sacrifices their economy. For instance, the recent antitrust fine which was imposed on Alibaba is $2.8 billion or 4% of Alibaba's domestic revenue in 2019. That's quite well below the maximum of 10% that could be imposed. While this regulatory clampdown is likely to continue in the near future, I personally do not think that it will have a huge impact if your investing horizon is of significant length.


If we looked back at recent history, 2018 was a year where the China market had the worst performance in the decade with the major indexes seeing losses of more than 24% due to a variety of reasons such as domestic woes and trade war. However, the China market recovered swiftly in 2019 and 2020 in rather similar fashion. I'm not saying the same will happen to the China market next year, but I'm not discounting the fact that there is a high likelihood that recoveries do happen sooner than what most people are expecting. And when that happens, it will be clear that this recent drawdown presents a good buying opportunity.


What's usually important in most investment strategies is the need to diversify. With the polarisation of U.S. and China economies, it's probably not a smart move to bet on either. Having elements of both in your portfolio sounds like a better bet. If Ray Dalio, founder of the world's largest hedge fund, is paying a lot of attention to the rise of China, I see no reason why we shouldn't be. This might make a lot of sense now especially with the U.S. indices hitting record highs and the China market in the slumps. If mean reversion is to happen, you know what's going to happen.


If you are more risk averse but still want to expose yourself to the China market, you might want to consider a risk parity approach in your portfolio where China bonds are included. Ray Dalio's All Weather China strategy fund has a 22% annualised return in the 22 months ending last July. In general, the China market is behaving similarly to the markets in most developed economies where the government bonds rally when the stocks fall. In the past week where the Chinese stocks are falling, China bonds rally. Including China bonds in your portfolio for risk parity purposes could help you in minimising your risk yet gaining the exposure which is happening in the China market.


Personally, I'm happy to continue to accumulate and gain exposure to the China market while waiting for the regulatory crackdown to blow over.


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